Yuan revaluation will be inflationary for the world

It looks as though the talk of RMB revaluation is heating up, thanks to recent tightening efforts by the Chinese central bank. Maybe the Google situation is another factor though, as the situation is ugly politically. Nothing soothes an ornery Schumer or Graham like RMB appreciation.

Hugh Hendry made the case last year for the yuan-oil connection, arguing that RMB appreciation led to oil appreciation. I'm not sure whether oil will be the commodity of choice (or even whether commodities will be the asset class of choice), but I believe yuan appreciation will be inflationary* for global markets.

I reproduced an RMB-crude oil chart to track changes myself. Last time it took six months for faster appreciation to translate into faster oil price increases.


*Update: I should clarify the use of the word inflationary. Inflation is the increase in the money supply of the currency. Only the Federal Reserve can inflate dollars, only the Russian central bank can inflate rubles, only the Bank of Japan can inflate yen (assuming no major counterfeiting operations are going on).

However, the raising of the RMB will be inflationary because RMB is undervalued. The inflation or devaluation of other currencies, especially U.S. dollars, has been hidden by the currency peg. When RMB is revalued, therefore, U.S. dollars come closer to their true lower value. Other countries have inflated as well, though, so what will happen is that China will strengthen versus the world and whatever the Chinese buy most will go up in price for everyone else. In 2008, that was oil.

Now, everyone else is also inflating like crazy, some worse than the Federal Reserve. In the U.S., for one, much of the inflated money is sitting in bank reserves because banks are financially weak and borrowers do not want more debt. There's a big inflation/deflation debate going on and the deflationists are winning right now, because the reserves lack a transmission mechanism to move out from beyond the bank reserves.

Revaluation of the RMB will lead to higher commodity prices, is my best guess. After that, one of two things will happen. One possibility is that it switches the world to high inflation. I don't see a direct link here, but I can't rule it out. More likely, it acts to repeat the 2008 crash, as high commodity prices sap the nascent recovery.