The new yuan reference rate – more a controlled scuttle than a free float

The Telegraph today, as part of an Ambrose Evans-Pritchard opinion piece on China’s yuan devaluation, offers a useful explanation of how the PBoC intends to manage its new floating exchange rate mechanism.

PBoC will set a reference rate daily in U.S. dollars and allow the yuan to float in a band of 2% on either side of that rate. It will then either buy or sell dollars “to steer the rate” presumably in the direction it deems most agreeable. Thus far that steering has taken a turn on the road that goes downhill. Overnight, China once again managed the float downward – another 1%.  That makes the plunge over four per cent since launch date. PBoC says this mechanism is more reflective of free market forces.

But is it?

Managing a currency within a band is far from allowing a currency to float freely, and why would any central bank these days embark on a policy like this unless it were to weaken the currency’s value. Had China’s intentions been otherwise, this new mechanism would have been unnecessary. No, China simply wants to manage its devaluation of the yuan – more a controlled scuttle than a free float.