Has China really been manipulating the yuan to make its exports relatively more attractive? Jonathan Anderson, the chief Asian economist for UBS, doesn't think so (China Should Speed Up the Yuan’s Rise):
Let’s recall how a fixed (or quasi-fixed, in China’s case) exchange-rate system works. China’s central bank, the People’s Bank of China, publishes a daily exchange-rate quote and stands ready to trade the yuan against foreign currency at or near that published rate. When there is an excess of dollars on the market, either because of a trade surplus or net capital inflows, the PBOC purchases those dollars by issuing new yuan; when dollars are in short supply, the PBOC sells its own dollar reserves to make up the difference, removing yuan liquidity from the market in the process.
Over the past few years, the rising trade surplus means that the People’s Bank has been a continual net buyer, accumulating nearly $30 billion a month in official foreign reserves for a cumulative total of $1.2 trillion as of March 2007. This fact has led to criticism that China consciously set the yuan peg at a level that makes exports hypercompetitive and thus automatically generate enormous trade surpluses. But this doesn’t necessarily follow. Under a fixed exchange-rate regime, central banks essentially commit to live with what the market delivers to their doorstep, and in a technical sense the recent flood of dollars is simply what the market has brought to China.
In fact, when looking at policy intent it helps to keep two points firmly in mind. First, when the government first initiated the peg in 1997 it wasn’t to keep the yuan from rising. Rather, it was to keep the currency from collapsing. The end of the Chinese bubble in 1995-96 left the economy with a huge burden of bad debts at home and abroad: Profits were disappearing and real growth had probably slowed to low single-digit levels. Against this backdrop, the onset of the Asian financial crisis convinced many investors that the yuan would be the next domino to fall, and short-term capital began to flow out of the economy at an unprecedented pace. The authorities’ decision to institute a de facto peg against the dollar was explicitly billed as a commitment not to devalue the yuan. As late as 2003, when then Premier Zhu Rongji officially retired from government service, he considered holding the yuan peg to be one of his crowning achievements, and one of China’s biggest contributions to global stability.
Secondly, the Chinese government has been as embarrassed as anyone else by the skyrocketing mainland trade balance. As late as mid-2004 China was running a trade deficit, and there was no sense whatsoever that the yuan might be structurally undervalued. It wasn’t until early 2005 that the trade surplus began to careen upwards to unprecedented heights—a trend that caught not only the government but also most outside observers by surprise. Consider the authorities’ position: At the beginning of this decade the yuan was trading around eight to the dollar and most economists were imploring them to keep the peg in order to avoid devaluation. Six years later, the exchange rate is still roughly eight to the dollar, but now foreign policy makers are screaming that the yuan is the most undervalued currency in the world.
This is hardly a case for manipulation. “Whiplash” is more the operative word, as China struggles to come to grips with the massive changes of the past few year.
This figure, from Menzie Chinn's web post, More on the Yuan and the Chinese Trade Balance (Econbrowser, July 16), has the following caption, "Log real trade weighted value of Chinese Yuan (blue, left scale), and Chinese trade balance in bn USD, at annual rate (red, right scale), and 12-month trailing moving average (green, right scale). Source: BIS and IMF, IFS." It illustrates the negative trade balance in early 2004, and the rapid increase in the surplus in subsequent years.
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