Oil and the Yuan
Beware of getting what you ask for. For months the US government has been pressuring China to revalue its currency, to help bring the huge and growing trade imbalance between the two countries under control. Now China has acted, releasing the Yuan from its dollar peg. Even though the initial change is only a 2% increase in the value of the Chinese currency relative to the dollar, the new policy apparently allows Beijing to adjust this rate each day, so over the course of a few months, we could be looking at a significant change. At least in the short run, the new policy is likely to put further pressure on oil prices and may even worsen the overall US trade deficit.

The problem is that under globalization, the financial world is tremendously interconnected and replete with feedback loops of different sensitivity and speed. The obvious goal on the part of the US is to make Chinese goods more expensive in dollar terms, reducing demand for them and reversing the trade deficit. However, this could take a long time, because as the Times article suggests, US retailers of Chinese goods may resist raising prices immediately. And as long as the Chinese government is content to hold the even larger number of dollars it will be receiving, investing them in T-bills or equities, the normal feedback mechanisms of the currency markets will not come into play.

But while we are waiting for demand for Chinese goods to slow, something else will happen almost immediately: the price of oil for Chinese companies and consumers will fall, since oil is denominated in dollars. Cheaper oil will mean faster demand growth, and at the scale we are talking about in China, a small change can result in large volumes, as we've seen in the last few years. This could be enough to forestall or overwhelm the slowing in Chinese oil demand that most analysts were expecting this year. And that means that oil prices will stay higher, longer than otherwise.

Since steeper oil prices translate into a bigger bill for our oil imports, our overall trade deficit will grow until another lagging feedback loop, US drivers' response to higher gas prices, kicks in. As a result, the net short-term result of the Chinese revaluation is likely to be contrary to what was expected. That doesn't mean that it isn't the right thing for everyone in the long run, but it certainly reinforces the idea that there are no quick fixes for our current economic problems.