Last month we talked about the Chinese policy to allow the yuan more flexibility. After the de-pegging the currency did strengthen, from 6.83 against the US$ to 6.77 - a 0.88 per cent rise - but the movement was smaller than expected.
Market commentators took the view that the policy, which was announced just days before the G20 summit, was aimed at releasing tensions over accusations that China was manipulating its currency.
If left to float freely, a currency's value will in theory be adjusted by market forces to the point where it balances trade surplus/deficit among countries. For example, the currency of country with a trade surplus will strengthen against that with a trade deficit. As a result, goods from a trade-surplus economy will be more expensive. On the other hand, goods from a trade-deficit economy will be cheaper as a result of its weaker currency. Trade flows will then result in a balancing out.
Unfortunately, currency theory does not match the reality. There are two main reasons for this. First, the currency market is not only a medium of trade but also an instrument that traders speculate with to make money. The interesting fact is that a higher volume of currency is used in foreign exchange trading than in trade flows.
Second, rather than a trade balance being the ultimate goal of policymakers, the reality is that a trade surplus and the accumulation of foreign reserves are their main objectives. To meet this objective, countries have in the past intentionally kept their currencies weak to gain a trade advantage.
Currency value therefore does not move in line with the theory. Given the distortions, market adjustment is either a very long process or not possible at all.
But if theory cannot explain or predict exchange rate levels, how can we possibly make forecasts? The answer is simple: no one is able to make consistently accurate predictions with regard to exchange rates. The only thing economists or traders can do is to offer the direction of movement based on economic indicators or techniques such as Technical Analysis, which uses charts to analyse trends.
For us, prudent risk management is the task at hand.
Padej Piroonsit is head of Treasury Sales at CIMB Thai Bank.