Monday, November 29, 2010

How Yuan Appreciation Helps China

Harvard economics professor Martin Feldstein says that China can control inflation and reduce the cost of imports by allowing its currency to appreciate. Since June the Yuan has only appreciated by 3.1 percent. See the following post from Economist's View.

Martin Feldstein says China will use QE as an excuse to accelerate appreciation in the renminbi:
Quantitative Easing and the Renminbi, by Martin Feldstein, Commentary, Project Syndicate: The United States Federal Reserve’s policy of “quantitative easing” is reducing the value of the dollar relative to other currencies that have floating exchange rates. ... The Fed’s goal may be to stimulate domestic activity in the US and to reduce the risk of deflation. But, intended or not, the increased supply of dollars also affects the international value of the dollar. ...

But the market forces that cause ... currencies to appreciate do not work on the renminbi, because China has only very limited capital-account convertibility. ... The Chinese government ... determines the renminbi’s exchange rate.

So the relevant question is how the Chinese government will choose to respond to the Fed’s quantitative easing and the impact of the Fed’s policy on other currencies. Between 2008 and June of this year, the Chinese held the renminbi at a fixed rate of 6.8 to the dollar. In June of this year, the Chinese authorities decided to allow the renminbi to appreciate at a moderate pace...

Indeed, in the five months since that announcement, the Chinese government has allowed the renminbi to appreciate by 3.1% – not much less than the average rate of appreciation that it allowed between 2006 and 2008. ...

Chinese Prime Minister Wen Jiabao has stressed that China does not want more rapid appreciation of the renminbi, because of the potential adverse impact on Chinese exporters. Rising Chinese exports between 2006 and 2008, despite renminbi appreciation, suggests that this worry is misplaced or at least exaggerated. But it is clear that ... the Fed’s policy of quantitative easing now gives the Chinese scope for more rapid appreciation of the renminbi relative to the dollar.

Greater scope for renminbi appreciation comes at a good time for China. A stronger renminbi would help to reduce rising inflationary pressure in China by reducing the cost of imports, which would also increase Chinese households’ real incomes – a key goal of China’s new five-year plan. ...

In short, the Fed’s policy of quantitative easing is likely to accelerate the rise of the renminbi – an outcome that is in China’s interest no less than it is in America’s. But don’t expect US officials to proclaim that goal openly, or Chinese officials to express their gratitude.
This post has been republished from Mark Thoma's blog, Economist's View.
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