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A few thoughts on China

Market Commentary

12 August 2015

The Chinese government announced that it will bring the fix in line with the currency and then let markets determine the FX rate going forward. This is exactly what is happening. Closing the gap between the fixing and market based valuations of the RMB is one of the key requirements for SDR inclusion. This action therefore takes China one step closer to SDR inclusion – set formally to happen this year with practical implementation starting around the time of the G20 summit to be held in China in November 2016 (where Obama will give his nod of approval as a final gesture before leaving office). SDR inclusion in turn is part of a much broader set of reforms. Remember why China is implementing reforms, including liberalising its currency regime. The entire purpose of the reforms is to prepare the economy for RMB appreciation, i.e. a rise in the Yuan once QE across the Western world creates inflation and currency weakness in the QE countries. Inflation is likely to begin in late 2016 in the US as the drags on consumers’ willingness to respond to plentiful and cheap liquidity from household deleveraging, negative housing equity and unemployment ease.

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