Chinese revaluation signals further dollar weakness

The first revaluation of the Chinese renminbi in almost a decade is deceptively small at 2.1%, and the move from a dollar peg to a basket of currencies was also widely expected.

But it signals an obvious fact of economic life. Currencies in growth economies will appreciate. Particularly those like China presently clocking up 9.5% annualized GDP growth.

And although it is true that this revaluation has been a long time coming, it is a sign of things to come, and this is decisively dollar negative. Indeed, this modest move by the Chinese authorities could yet be seen as a landmark shift in the world economy.

Some commentators have harked back to the Thai devaluation of the Baht in 1998 which triggered the Asian Financial Crisis. That might be alarmist, but all financial tidal waves begin with a ripple in the water.

The six GCC currencies are linked to the US dollar and effectively greenbacks. And for GCC central bankers the policy dilemmas of dollar pegging are well known.

A weaker dollar increases import costs and raises inflation in the Gulf States. Interest rates tend to be set lower than they should be, especially at a time of booming oil revenues. Yet at the same time Gulf States become more competitive for tourism, and higher oil prices do not damage the euro zone as much as they would with a higher dollar.

A lower dollar is helping the GCC real estate sector to boom with low interest rates and lower prices in foreign currency terms. On the other hand, it is driving up the cost of imported building materials and equipment.

The UAE Central Bank has already let it be known that it is considering placing 5% of its reserves into euros, and in the face of further expected dollar weakness this diversification should become a trend, among other GCC States as well as the UAE.

Indeed, the bond market has already responded to the news that China is to rebalance its foreign exchange holdings towards the euro and yen. It would only be logical for Gulf States to follow this lead, if only to protect the value of their exchange reserves.

Whether that means that Gulf currencies will break their dollar peg is another debate entirely, but the Chinese action does tend to suggest that this is now more a matter of when rather than if. However, timing in foreign currency markets is for the brave or foolish.