The Modification of the Chinese Exchange Rate Policy

Abstract

On 21st July 2005, the Chinese Central Bank revalued the yuan from 8.27 to 8.11 per US dollar. This small revaluation (2.1%) was accompanied by an official modification of the exchange rate system. The authorities announced that "the yuan will be no longer pegged to the US dollar" and that "China will reform the exchange rate regime by moving into a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies" 2. They did not publish details of the composition of this basket. The revaluation occurred during an intense two-year long debate, among scholars and political leaders about Chinese exchange rate policy, since 2003. American policymakers have often complained that the yuan has long been significantly undervalued, giving China an unfair trade advantage. Thus, China is blamed for a "currency manipulation" that induces job losses in the United States, Japan, Europe and other Asian countries, threatening world economic equilibrium. The yuan being revalued, one might think, is due to China yielding to this international pressure (and recognising its responsibility in the imbalance in world trade). This paper suggests that this interpretation is simplistic and misleading. First of all, it has been demonstrated that for 25 years the Chinese exchange rate policy has aimed at both internal and external targets-and not only export competitiveness 3. Consequently, both must be taken into account in interpreting any exchange rate policy modification. Following this, this paper looks at the rationale behind the recent modification of the Chinese exchange rate policy in reviewing the two debates on the need for revaluation and greater flexibility. The last section explores the short-run impact of this decision. The debate on the revaluationIs the yuan undervalued? To provide empirical elements to the debate on the undervaluation of the yuan, numerous studies have recently been dedicated to the assessment of misalignment of

Implications of Yuan/dollar exchange rate for trade

“…In a series of studies, Cline and Williamson (2010b, a and 2011a, b) found a 40.2 percent undervaluation in January 2010, a 24.2 percent undervaluation in June 2010, a 28.5 percent undervaluation in May 2011, and a 23.5 percent undervaluation in November 2011. Goujon and Guérineau (2006) observed that 10‐15 percent misalignment is more reasonable. Even though the methods and range of Yuan undervaluation varies in these studies, it is generally agreed that the Yuan is indeed undervalued.…”

“…Between 1995 and 2005, the Yuan was pegged to the US dollar at 8.28 Y/$ (Poleg, 2005). The USA considered the Yuan to be undervalued at this fixed rate (Goujon and Guérineau, 2006), which allowed China to export more to and import less from the USA, creating a bilateral trade deficit that has been a major concern for the USA (Labonte and Morrison, 2011). Therefore, several bills were considered by USA.…”

“…This managed float, also known as a dirty float, allows the Yuan to be determined by market forces within a certain band set by Chinese monetary authorities, but it is susceptible to misalignment because it is not completely determined by currency supply and demand (Appiah‐Danquah, 2011). This policy caused the Yuan to appreciate by 2.1 percent to 8.11 Y/$ (Goujon and Guérineau, 2006). After this appreciation, the Yuan was allowed to fluctuate within a band of 0.3 percent under this managed‐float currency regime (Frankel and Wei, 2007).…”

“…The USA is trying to convince China to revalue its Yuan by emphasizing that a revaluation would be beneficial to China because it would decrease the amount of “hot money” inflows, decrease inflation, and make it less difficult to reform the Chinese banking system (Goujon and Guérineau, 2006). It would also decrease the risk of protectionism from other countries.…”

The effects of the Yuan‐dollar exchange rate on agricultural commodity trade between the United States, China, and their competitors

“…The Yuan started to appreciate from 8.11 Y/$ in 2005 to 6.83 Y/$ in 2008, and then stalled in 2008 due to the financial crisis when it was repegged to the U.S. dollar (U.S. International Trade Commission, ). It then resumed appreciation in 2010 and reached 6.21 Y/$ in 2012 (U.S. Department of Agriculture, ), but many studies conclude that the Yuan is still undervalued (Reisen, ; Goujon and Guérineau, ; Rodrik, ; Subramanian, ; Cline and Williamson, , , and ; IMF, ; U.S. Department of Treasury, ). For example, Subramanian () estimated a 30% undervaluation of the Yuan in April 2010 and Ferguson and Schularick () estimated that the Yuan was undervalued between 30% and 40% for the period of 1980–2008.…”