China's Widening of Yuan Trading Range Is Meaningless Gesture

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK (TheStreet) -- Sunday, Beijing announced it was widening the daily trading range for the yuan to 1% against the dollar.

Some are heralding this news as another indication that China is liberalizing its currency and that the yuan may now be fairly valued.

They're wrong.

In May 2007, when no one would dispute the yuan was undervalued by a wide range -- by my reckoning, some 40% -- China widened the trading range to 0.5% from 0.3% points to no substantial effect.

Theoretically, if market pressures require, the new band should permit the currency to appreciate or depreciate 1% each day, but in the past, official intervention has frustrated this process.

8 Fertilizer Stocks Primed for Growth

Bejiing did not let the yuan appreciate 0.3% or 0.5% percent each day when those respective bands applied.

The resulting pace of appreciation was substantially less than private market forces and these trading bands should have required as evidenced by Beijing's accumulation of some $3.2 trillion in foreign currency reserves.

We have no reason to believe things will be any different with a 1% percent band, should upward pressures on the yuan reemerge, as those likely will.

In recent months, the value of the yuan has appeared quite stable, despite persistent Chinese trade surpluses. The reported February deficit was a one-off, not repeated in March, and was caused by the annual nadir in exports associated with the Chinese New Year. Also, partner country statistics historically indicate China's trade surplus is larger than Beijing reports.

Capital flows also influence the underlying market value of the yuan -- the value that would be attained in the absence of persistent official intervention.

Recent revelations of working conditions in Chinese factories, disregard for foreign investors' intellectual property, new restrictions on foreign investment in sectors like autos, and concerns about a Chinese property bubble and the solvency of banks may be contributing to a drop-off in foreign investor interest in China.

10 Stocks That Fidelity Funds Are Buying

Both foreign and domestic businesses may be holding off a bit on expansion plans and looking for other options in Asia.

Also, Chinese officials have liberalized a bit on the capital account, permitting Chinese exporters to keep some of the dollars they earn from foreign sales, and permitting private firms to be more aggressive in acquiring assets abroad. This is creating some temporary downward pressure on the value of the yuan.

All of these capital account pressures on the underlying market value of the yuan are likely temporary, and on the basis of the trade account, the yuan remains overvalued.

When assessed in terms of differences in productivity growth and inflation between the U.S. and China, the yuan appreciation permitted by Beijing since May 2007, has not changed the fundamental undervaluation. The currency has been permitted to appreciate in line with net changes in productivity and inflation, and the underlying undervaluation of the currency remains in tact.

9 Stocks That Prove Dividends Make All the Difference

Hence, over the long term, the yuan is likely still undervalued by some 40%.