However, the yuan is not yet a freely convertible currency. Under the managed floating exchange rate regime the Chinese authorities hold the power to determine its currency exchange rate. Currently, financial experts can only determine the real supply-demand relations of the yuan measured in the overseas non-deliverable forward (NDF) market and the domestic black market. Therefore, it is complicated and tricky to accurately forecast the future of the Chinese yuan.
From the previous analysis we can see that the pressure of the yuan revaluation is gradually increasing over the years, the Chinese authorities’ decision to revalue the yuan is impacted largely in response to Western countries, however. For example, the yuan exchange rate is a key topic within the China-U.S. dialogues. As a result, many Chinese citizens already consider the yuan exchange rate to be largely a political issue resulting from “Western powers interfering with China’s internal affairs.”
Then why would the United States and other Western countries pressure the Chinese authorities for yuan revaluation? On the surface, the United States has called for a revaluation of yuan because of China’s large trade surplus with the United States, and China’s export market with cheap labours which have defeated the U.S. manufacturing industry.
But you may wonder: if millions of Americans enjoy the inexpensive Chinese goods, doesn’t that benefit Americans? Also many U.S.-based multinational companies benefit from China’s export advantage because they produce goods in that country for export to the United States.
The grounds on which the United States and the European powers have been calling for a revaluation are that the undervalued yuan has given Chinese exporters unfair advantages over their international competitors, contributing to the U.S. trade deficit with China and to the job losses in the U.S. manufacturing industry. Some also believe that the undervalued yuan may lead to deflation in neighboring countries and economic slowdown in the world.
In fact, what Western countries actually oppose is China’s managed floating rate regime, with which the authorities have continued to engage daily in heavy market intervention to curb the rise in the yuan. From the perspective of the Western countries, the economic activity should follow objective laws, and manipulative control of monetary policy will destabilize the macro economy. The Chinese authorities should change their foreign exchange system to a freely floating one in which the authorities in principle do not intervene in the market, and leave determination of the exchange rate to the demand and supply of the currency in the market.
He Zhicheng, senior analyst of the Agricultural Bank of China points out in his recent article that no full convertibility of yuan may adversely impact the current global economic crisis. He says that the financial crisis actually originated from an economic unbalance, suggesting that the monetary overflow and overheated economy is the root cause of this unbalance.
He asks, “Why have so many enterprises become bankrupt in China right now? Six months ago these entrepreneurs were still full of hope for their future. They’ve tried to increase production reserve. At that time, the currency exchange rate didn't give any warning signal for likelihood that the economy may cool down. Why would the currency suddenly lose its power to indicate this? The biggest reason is that the yuan exchange rate mechanism has not been ameliorated with the continuous improvement of the marketization in the economy.”
He considers the source of the disturbance in the global currency system and the global economy to be this overheated market. “People cannot only look at the U.S. and subordinated debts. When you observe the situation in China you find that the signal of the yuan value has been overlooked for a long time, so the economic forecast of this environment is naturally overheated, and corporations dare to blindly overreach.
The result is that any insignificant trifle will cause these corporations to overproduce, leading to debility or even bankruptcy. Therefore, the Chinese monetary authorities’ reluctance to follow world market trends does not just serve to keep its standing in China, it also leads to this overheated economy and is one of the sources leading to this economic crisis,” says He.
As for the so called exporting guarantee, the undervalued yuan didn't bring the country direct economic benefits in the short term. In fact, this currency manipulation brought obvious side effects to China’s macro-economy and financial market.
First, the Central Bank’s monetary policy independence has been restricted. The large inflows in foreign investment have contributed to a rapid buildup of China’s international reserves in recent years. The capital inflow plus a trade surplus bring a large sum of dollars into the hands of Chinese and will naturally push up the value of the yuan. In order to keep yuan pegged to dollar to maintain its role as the proxy-exporter, the Chinese authorities buy up those dollars that flow into China. The buying of dollars means the selling of yuan, or the issuance of a large amount of new yuan by the authorities. The Central Bank is not able to absorb all those newly released yuan through its monetary operations. The remaining newly issued yuan thus flows into the hands of state controlled banks.
Local Chinese authorities borrow those newly issued yuan from local branches of those state-owned banks and build power plants, steal mills, super size textile factories, infrastructures and even engage in real estate speculations. When larger amounts of money flooded the stock market and real estate market, the result was a severe deviation from the real value of asset prices, creating small and big bubbles.
Second, China has accumulated foreign exchange reserves excessively. Its foreign-exchange reserves once rose to a world record US$1.906 trillion. Therefore Chinese companies which are government-backed have access to funds they can transfer to assets outside China. Such a huge amount of funds operating overseas may not be allocated to useful purposes, and will create risks for the growth of the domestic economy, under the global financial crisis.
Third, enormous amounts of money flow into China, excessively overflowing the market. The increase of commodity pricing and material costs will eventually damage the external competitiveness of the country’s production industry. It will also bring with it other side effects, such as an overheated economy, asset price bubbles and more.
Of course, Western countries’ demands for yuan appreciation is not only about maintaining market balance, but also entails non-economic considerations. While these cheap Chinese products may seem like a bargain, consider that they largely come from sweatshops in which workers are exploited for little money. This system is built upon suppressing laborers and often produces significant environmental pollution. Therefore, trade negotiations frequently request Chinese enterprises to build real labor unions. This may be what Chinese authorities refer to as “interfering with internal politics.”
Read this article in Chinese.
