The People?s Bank of China (PBC) announced on June 19 that it is prepared to allow the yuan?also called the renminbi?to float more freely against the dollar and other foreign currencies. President Barack Obama hailed the move and said, ?China?s decision to increase the flexibility of its exchange rate is a constructive step that can help safeguard the recovery and contribute to a more balanced global economy.? Leaders from Europe, Japan and Russia also cheered this currency regime shift long-due from China.

Stock markets rose sharply on June 21 following the announcement. Globally, investors have welcomed the move because it lowers the risk of a future trade conflict that could hamper global growth. It has also strengthened investor confidence, which has been shaken by the debt problems in Europe and the gloomy economic data from the US. A flexible currency regime from the manufacturing powerhouse was what the rest of the world had wanted for a long time so that there could be an economic order, allowing global trade to grow steadily without artificial government stimulus.

Beijing has faced severe criticism in the last few years from the international community, especially the US, for holding the yuan artificially cheap. PBC?s currency strategy has kept the country?s export juggernaut rolling, which has severely impacted the manufacturing sector in many countries around the world. The central bank surprised everyone by saying that it would make the yuan more flexible. To put it in context, the statement comes before the G-20 meeting to be held in Toronto from June 26, where US and Chinese officials were in for a showdown on future prospects for the peg. The US has been arguing for long that China has held its currency severely undervalued. It alleged that undervaluation of the Chinese currency is a blatant form of protectionism and that it subsidises all Chinese exports by the amount of the undervaluation, which is estimated to be anywhere between 25% and 40%. The currency undervaluation also means that Chinese companies find it less economical to import because it costs them more in their local currency. It is similar to an import tariff of 25% to 40% being levied on all imports into China, thereby strongly discouraging purchases from other countries.

The strategy of the central bank seems to suggest that China doesn?t want the G-20 meetings to focus on the currency peg. It would want the spotlight to be on issues such as the European debt crisis and rising budget deficits in Europe and the US. PBC holds foreign currency reserves in excess of $2.4 trillion. Widening fiscal deficits in developed economies due to reckless spending by their governments could cause the value of China?s foreign currency holdings to decline sharply. With this announcement on the table, it enables China to press forth issues that are important on its agenda and at the same time eases pressure from the international community for meaningful currency reform.

The statement to revalue the yuan would seem innocuous, benign, apolitical and could have been taken at face value, if the euro-dollar exchange rate were at more favourable levels. The euro has been tumbling in value against the dollar this year. From a level of 1.514 in November 2009, the euro to dollar exchange went below 1.200 this month for the first time in four years. At the beginning of this month, $1.1917 fetched 1 euro. The value of the euro has declined more than 20% in less than seven months. This steep decrease in the euro?s value has been due to problems in Greece, the massive relief package assembled by the European Economic Union to bail out the country and economic storm clouds hanging over Portugal and Spain, among others. Decline in the value of the euro against the dollar means that not only has the dollar appreciated in value against the euro, but so has the yuan. This appreciation of the yuan has made Chinese goods cost 20% more in Europe now than they did seven months back. Further declines in the euro due to the deterioration of the fiscal situation may cause Chinese goods to cost even more in Europe, apart from reducing the value of the PBC?s forex reserves. A revaluation against the dollar, as the PBC announced on Saturday, could make the yuan appreciate even faster. Given the yuan?s appreciation due to the euro weakening, China would be reluctant to allow for a sizeable move in its currency since the EU is the second largest trading partner for China. A decline in trade with the EU is something that China really would not want, given that the Chinese economy is growing at a marginally slower pace now, due to the not-so-robust global economic environment.

Not surprisingly, the central bank was rather vague as to the amount of appreciation it will allow. The details are yet to be revealed but if anything, we can expect a very small appreciation in the near future, which isn?t exactly what the international community has been demanding. While the statement is a positive gesture, it is exactly that (i.e., it is nothing more than just a gesture). Expect the stock markets? euphoria to wane pretty quickly because what you hear isn?t necessarily what you get.

The author, formerly with JPMorganChase, is CEO, Quantum Phinance