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What’s the Reality Behind the Fixed Yuan?
Shang Nong
5/24/2005



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Speculation on the revaluation of the yuan remains one of the hottest topics in modern economics and commerce. Yet much of the discussion is based on flawed understandings of Chinese economics. Indeed, why does the Chinese regime appear so reluctant to bend to international pressure?

The story begins back in 1995 when the exchange rate for the yuan was fixed at 8.28 to 1 US dollar. As Chinese exports began to create trade imbalances in the world’s trading blocs, the economic powerhouses of the US, Europe and Japan began to lose patience with the Chinese economic stance. They accused China of pursuing an unfair competitive advantage in exports by not allowing the value of the yuan to appreciate against the US dollar.

Last year, China’s exports increased 35 percent to 593.4 billion dollars. Its trade surplus reached 32 billion dollars, the highest since 1998. Also last year, the Unites States’ trade deficit with China reached a record high of 62 billion dollars.

Meanwhile, American manufacturers have long complained that the yuan is undervalued by about 40 percent. This year, US trade representatives have exerted sustained pressure on China to appreciate the yuan, or face import tariffs on Chinese goods entering the US market.

The benefits of a more powerful yuan would be felt immediately by Chinese people. They would, for example pay less for McDonald burgers, US-made Buick cars and Sony sound systems from Japan. Chinese tourists in South Asia or European countries would be able to buy more foreign goods with their more powerful currency.

An appreciated yuan will, almost certainly, have a negative impact on exports. But by encouraging imports, it will flatten the current trade imbalance and will help to form long-term mutually beneficial trade relations with other countries. Trading relationships that are one-sided is unreasonable and unsustainable. If China wants to be seen as a respected player in the international community, it should place great value on mutually beneficial trade.

What are the possible effects of a stronger yuan? Goldman Sachs predicted last month that if the yuan appreciates by 5 percent, the current trade surplus would shrink by more than half. If the value of the yuan goes up by 10 percent, exports would shrink by 15 percent and the current trade surplus would turn into a small trade deficit.

According to an official Chinese study, a 3 to 5 percent appreciation of the yuan would slow the growth of exports to less than 10 percent. An appreciation of more than 15 percent would see a decline in exports.

All predictions on when the Chinese would move on appreciation have been proven wrong. The most recent are the Morgan-Chase bet on 8 May, which passed without incident. And the Goldman Sachs prediction of 18 May, the day the foreign exchange system expanded its trading volume, also fell flat.

But the question still remains. Why is there simply no movement whatsoever by the regime on the exchange rate? Surely a piecemeal approach to revaluation could be adopted to minimize the export pain? There must be a deeper reason.

According to electronic media reports from Hong Kong, the Chinese National Bureau of Statistics has issued articles warnings that if RMB’s value rises by too much, there will be an outflow of cash off shore seeking interest rate returns. This could trigger a short-term weakness in the yuan.

At an annual Asian banking meeting in Istanbul last week Chinese Treasury Secretary Jin Renqing said the increasing speculation on the revaluation made the actual revaluation too difficult. This has led some to think that Chinese intransigence is aimed at profit-taking by currency speculators.

But such thinking does not really hold water. As long as any trade or exchange occurs with China, no mater what the value of the yuan, there is always the danger of money going off shore to profit from interest rates. But that is true for every single country in the world, China is no different.

The facts of a stronger yuan, especially where the rise is controlled incrementally by the government, are not such that the regime should continue to resist the move. The real facts may have already been stated by Professor Lui Zuenyi of Hong Kong University who thinks that the yuan, and the economy itself, just doesn’t have the right fundamentals to allow it to appreciate.

Much of the current attraction to China is the promise of huge profits to be made. The population in the cities and country are expected to become wealthy and massively upscale their purchasing power. But any cursory review of the bad debt crisis facing banks, over investment in stocks, a wide array of deep social crises and the fact a huge majority of the population actually faces poverty, will highlight that the promised bright economic future for China is not backed reality. A slowdown in exports will lead to a reduction in foreign investment and economic growth will slow.

Despite the fact that the reported growth numbers are probably not real anyway, the illusion of growth, built up by the government and foreigners it has managed to win over, will disappear. This is what really scares the government. This is what it can’t face. It cannot bear the cold light of reality dispelling the fog of illusion it has managed to create. Given the real problems in China, a stronger yuan may be some way off.


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