Yuan Valuation: Flirting with Disaster

This will be a short post, but expect a much longer post later today.

Today, the government of China finally bowed to US pressure and decided to scrap its decade old peg to the dollar. The new yuan rate versus the dollar revalues the currency by 2.1 percent, to 8.11 per U.S. dollar.

First, various studies, including some from the Federal reserve in Cleveland, have said that the Yuan is overvalued and not undervalued. (Full disclosure: there are plenty of studies pointing the other way as well.) I think this was a can of worms that was better left unopened.

Second, the amount of US debt that China and Japan own is enormous. Has anyone even given a second to think about what the currency floating will do to this? What would happen if some wacko communist party hack decided that it was a good idea to dump all that debt? We could be in a depression in a matter of seconds. I'm not sure we would be, but something tells me that we should be worried about something that has never happened before and that will adversely affect the world's biggest economy.

Third, I am very pro-currency floating. (I'm no crazy libertarian saying central banks should not exist.) But as a friend once told me after he was asked about China's national savings in a consulting interview: it's a freaking communist country, how am I supposed to know what they'll do next? And that is scary.