China in Transition
Chinese Economists Calling for a Stronger Yuan
Chi Hung KWAN Consulting Fellow, RIETI
Amid heightened calls from Japan and Western countries for the yuan's appreciation, the Chinese media are presenting emotional arguments against such a move, viewing these demands as a conspiracy to stop China's economic development. However, we are beginning to see more varied opinions among experts, including those who support appreciation, and with overheating of the economy becoming more and more apparent, the authorities are also starting to show a more flexible stance toward exchange rate policy.
Firstly, during his meeting with U.S. Treasury Secretary John Snow on September 3, Premier Wen Jiabao reiterated the official line that, "Maintaining exchange rate stability benefits both China and the United States." However, at the same time, he also left room for discussion regarding changes in exchange rates. More specifically, Wen said that the implementation of the prevailing managed floating exchange rate system based on market supply and demand matches China's current condition. He also added that, "Along with financial reform, China will further perfect the exchange rate regime taking into consideration its economic development and performance, as well as the international balance of payments." The fact that China has already adopted a managed floating exchange rate system, together with Wen's remarks that the mechanism which determines the yuan's exchange rate needs adjusting indeed indicate that the authorities no longer insist upon maintaining the dollar peg. Indeed, Dai Genyou, head of the monetary policy department of the People's Bank of China, professed in an interview which ran in the July 24 edition of The Financial Times that, "The size of the fluctuation of the exchange rate is in the final analysis the natural result of the market."
Amid such an atmosphere, some academics have also begun to voice their clear support for a stronger yuan. Chief among them, especially noteworthy is an essay entitled "Let us Dispel the Morbid Fear of a Strong Yuan" (Chinese Only) written by Dr. Yu Yongding, head of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences and greatly trusted by the Chinese government, that appeared in the institute's International Economic Review. Based on the recognition that the current yuan rate is cheap compared to the fundamentals of China's economy, Dr. Yu criticizes the views presented in the Chinese media that oppose the strengthening of the yuan. The points of his argument are as follows. Firstly, there has been concern that an appreciation of the yuan would dent external demand and threaten to negatively affect trade balance and economic growth (and furthermore, employment). However, because import contents constitute a high percentage of China's exports, even if exports decelerate the effects on growth and employment would be limited. Also, while it is said that appreciating the currency would only fuel expectations for further appreciation, neither is there any guarantee that speculation will be held in check if the government tries to maintain the current rate. Furthermore, while there are some who fear that an appreciation of the yuan will spur deflation, at present, inflationary pressure is rising as a result of the excess liquidity brought about by the central bank's intervention in currency markets, in an effort to block the yuan's rise. In order to control money supply growth, the central bank has adopted sterilizing policies such as issuing bonds, but Yu also points out that the cost of such measures, including interest payments, is very high.
There are other scholars who also support the yuan's appreciation. Hu Zuliu, professor at Tsinghua University, maintains that based on the "Holy Trinity of Hypothesis" - that independent monetary policy, capital mobility and fixed exchange rates cannot be simultaneously achieved - China should abandon its de facto dollar peg in order to maintain the effectiveness of its monetary policy amid increasing capital mobility. ("China Needs to Fundamentally Reform its Foreign Exchange System," (Chinese Only) Study Trends, Center of Chinese Studies, Tsinghua University, June 9, 2002). Also, on the issue of foreign exchange stability, some economists assert that the matter should be approached not just with the dollar in mind, but through an "effective exchange rate" that also takes into account other major currencies such as the yen and the euro ("A Healthy and Stable Foreign Exchange Policy Contributes to the Healthy Growth of the Chinese Economy," (Japanese Only) Chen Mingxing, Economic Forecast Division, State Information Center, and Shi Dan, assistant professor at the School of International Trade and Economics, University of International Business and Economics, Sina Finance, Aug. 4). Under the current situation where the dollar is falling against both the yen and the euro, stabilizing its effective exchange rate would immediately mean an appreciation of the yuan against the dollar. The views of these scholars, which differ from the arguments of both the Chinese and foreign media, are rather closer to the opinions I myself have stuck to in this column (see note).
With China showing signs of compromise, it is likely that we will begin to see active moves to strive for a "soft landing" regarding the yuan appreciation issue. When we consider the fact that the Chinese government would not want to give the impression to the public that it caved in to foreign pressure, it will first have to explain to its citizens that changes in its exchange rate policy are not for the benefit of the U.S., Japan or Europe, but are in the best interests of China itself. Many economists have already prepared the theoretical basis for this. Although such calls for a stronger yuan are still the minority in China, once it becomes the mainstream in the media, which reflects the will of the government, the appreciation of the yuan may be close at hand.
- The Chinese translation of my work "Why the Yuan Needs to be Appreciated - it is Beneficial to China Itself, not Japan" (Japanese Only) can be found in the economic magazine Comparative Studies (Issue No. 7, July 2003).
September 5, 2003
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