Pnyin - Long-term RMB reform benefits China and US

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Long-term RMB reform benefits China and US
By He Fan
Updated: 2007-08-07 07:11




The reform to China's exchange regime is being carried out in a
market-orientated means toward a long-term target. Turing it into a
political issue would only harm the process or even tarnish the ultimate
target itself.

China's exchange regime is one of the major topics in the Strategic
Economic Dialogue between China and the United States, which began in
September 2006. The talks are only one indication of the US government's
concern over China's exchange rate.

Before commenting on America's over-concern, it is necessary to examine
the gains and losses of the US on the renminbi exchange rate issue.

Will the United States reap great benefit from a significant renminbi
appreciation? Certainly not.

China will see reduced exports as a consequence of renminbi appreciation,
but the US will not stop buying the necessities it requires. US importers
may turn to other developing countries. But if the commodities from those
countries are more expensive than Chinese goods, the switch does not
improve the US's international balance by reducing its trade deficit.

If China loses its share of the international market for the yuan
appreciation, its economic growth will be slowed, cutting down its
imports from the US. It will not help reduce the US trade deficit, either.

Commodity trade aside, the renminbi's appreciation will also hurt the US
in capital account items. US direct investment will become less rewarding
after the yuan gains against the US dollar, decreasing US profit from
international investment.

As a matter of fact, the US has more to gain if China maintains the
renminbi at a stable level.

When the US manufacturers shift their factories into China for the
relatively lower costs here, US customers still enjoy the products by
importing them from China. The consumption of resources, energy and the
pollution to the environment during the manufacturing process are all
left in China.

When the yuan is stable, the US has a more important advantage.

Thanks to the trade surplus, China has accumulated a large sum of US
dollars and its world largest foreign exchange reserve is mostly in US
dollars. Such a big sum, a considerable portion of which is in the form
of US treasury bonds, contributes a great deal to maintaining the
position of the US dollar as an international currency.

Russia, Switzerland and several other countries have restructured their
foreign exchange reserve and reduced the US dollars they hold. China is
unlikely to follow suit as long as yuan's exchange rate is stable against
the US dollar.

The Chinese central bank will be forced to sell US dollars once the
renminbi appreciates dramatically, which might lead to a mass
depreciation of the US dollar against other currencies.

The Chinese government launched an exchange reform regime years ago. The
renminbi will be appreciated gradually, the exchange regime would evolve
in a managed floating exchange rate system and an effective foreign
currency market would be established.

China made such a choice because the former arrangement of pegging to the
US dollar might weaken China's flexibility in monetary policies. And it
has also realized that an undervalued yuan will slow the industrial
restructuring and cause vicious competition among Chinese exporters.

However, this reform is only part of a much bigger effort to upgrade the
country's industrial structure. The exchange regime is not going to
finish the task single-handedly.

First of all, the exchange regime reform is not a solution to tackle
China's trade surplus. China's exports are mainly propelled by the
processing trade, which is not sensible to the exchange rate. Even if the
renminbi does rise dramatically, the processing trade is not going to
drop instantly and the trade surplus may not diminish. Figures from Japan
and China's Taiwan Province, where the processing trade used to dominate,
have also indicated a lasting surplus in the case of an appreciation of
local currency.

The exchange regime's reform will not put the lopsided industrial
structure into balance by itself. Theoretically, a changing rate would
help promote the development of industries that are not trade-orientated,
in China's case, the tertiary sector.

However, China's tertiary sector was fledgling for multiple reasons,
including inadequate supply of qualified talent and underdeveloped
infrastructure. Such factors are not easily improved by the exchange
regime reform.

Therefore, an objective view about exchange regime reform is
indispensable when people discuss the renminbi exchange rate.

The exchange rate equals a price between currencies in economic theories.
Price is the key to allocating resources, which would bear remarkable
significance for all resources in the market.

The Chinese government is determined to further this reform, but only
according to its own blueprint. The greater target might be tarnished if
the exchange regime reform is boiled down to the appreciation of
renminbi. How much should the yuan be appreciated? How long will it rise?
Similar questions should find their answers from the progress in related
fields. No one can give definite answers before the progress is achieved.

It would be totally against the rule of the market economy when a
country, through a political course, asks the Chinese government to
change a key price in the economy. It is both unwise politically and
unrealistic to ask China to realize the targets for its long-term reform
in a short time.

The Strategic Economic Dialogue is a constructive innovation to eliminate
bilateral misunderstanding, pinpoint the strategic issues of common
concern and maximize the benefits of Sino-US cooperation. It may cost the
chance of cooperation if the US insists on politicizing China's exchange
regime reform and the political shortsighted doggedness will also lead to
the neglect of more important issues.

The author is a researcher with the Institute of World Economics and
Politics at the China Academy of Social Sciences


















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