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More flexible RMB will help China?

Updated: 2011-05-20 13:37

By Hua Xiuping (chinadaily.com.cn)

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Many Americans are blaming America's deficits on China's RMB exchange rate policy. In their view, China's unfair trade and exchange rate policy is also destroying the US economy in some other ways, such as bringing higher unemployment rates.

In fact, a bunch of US politicians have been very serious about forcing a sharp and rapid RMB appreciation in the last several years. At the same time, the United States has been accused of deliberately attempting to depreciate the dollar since the global financial crisis. The second run of quantitative easing in November 2010 adopted by the US Federal Reserve was seen by the rest of the world as an apparent attempt to influence its currency's value.

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Without any doubt, many Chinese hate facing this kind of RMB appreciation pressure and even regard it as a big American conspiracy aiming to hamper China's fast-growing economy. The reasons are manifold.

First, although many economists have tried to prove that the fair value of the Chinese currency is considerably higher, no one is able to provide persuasive evidence on the alleged undervaluation of the currency.

Second, the United States is running deficits with all of its trading partners, which proves that America obviously owes its sorry state of affairs to living beyond its means by borrowing against its future, not by China's unfair policy itself.

Third, a sharp appreciation will harm China's export competitiveness and generate adverse effects on employment in tradable sectors, which is exactly what policymakers are trying to avoid.

Fourth, many worry that speculative capital inflows or outflows accompanying different RMB appreciation expectations may cause a boom-bust cycle in China's financial and property markets.

Given such reasons, most ordinary Chinese people, businessmen, and politicians advocate that RMB policy should stick to its own stance and yuan value should continue to be held relatively stable against the dollar. A very popular opinion is that China must make relevant policies based on its own well-being, not others' pressure and directions. Some even believe that "the enemy of my enemy is my friend," namely, because Americans want Chinese to appreciate the RMB, we shall do the opposite. As a warning to China against revaluation, the Plaza Accord of 1985 has been among the most cited words in Chinese media when discussing related issues.

However, we may need to inquire further. Has China also suffered from the dollar-peg policy? A short answer: Yes!

Every coin has two sides. Raghuram Rajan, professor of finance at the Booth School of Business at the University of Chicago, wrote an essay arguing that the current tension over currencies reflects the unsustainable trade imbalances and it is in both Chinese and American long-term interest that the US shall cut its spending while China shall expand its domestic demand. He is utterly right!

In addition to the well-known adverse effects such as suppressed domestic consumption and distorted economic structures, it is also widely noted that the yuan's peg to the dollar has given up independent domestic monetary policy to some extent.

The inflation cost of maintaining a dollar-peg exchange rate policy is high as well. For example, just after the global financial crisis, keeping a stable value of yuan against the dollar has created too much domestic liquidity due to the impact of recovered international trade as well as other countries' quantitative easing policies.

Yi Gang, the vice governor of China's central bank, also argued in February that China's most recent lingering inflation problem is rooted in its imbalanced trade and the inflexible exchange rate regime.

Obviously it is just no longer the optimal choice for China to stick to a dollar-peg policy if we want to reduce trade surplus and stimulate internal demand. To play a key role in the international financial arena, China has to be more open and learn how to manage risks.

With higher risks come greater profits. It is just the time to have a much more flexible RMB policy. A change to the free float or a managed float with a much wider fluctuation range will help China fare better!

Dr Xiuping Hua is assistant professor in Finance, Nottingham University Business School (NUBS), University of Nottingham Ningbo China (UNNC). The views expressed here do not necessarily reflect those of the China Daily website.


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