Since May, the question of whether the Chinese yuan should be revalued has been a hot international issues. In the wake of US Secretary of the Treasury John Snow's visit to Japan and China, the issue has once again reached boiling point.
Pressure to revalue the yuan mainly come from two sides -- international politics and China's domestic economy. Until these pressures can be dissolved, this will continue to be a hot issue.
The external pressure to revalue the yuan is mainly based on two facts -- China has a balance of payments surplus and the yuan is seriously undervalued. Last year, Chinese exports grew by 22 percent and the trade surplus reached US$30.4 billion. During the first seven months of this year, exports grew by an even higher 33 percent. China last year surpassed the US to become the world's largest recipient of direct foreign investment, attracting a total of US$52.7 billion. It has already attracted US$30.3 billion in such investment during the first half of this year. By the end of June, China's foreign exchange reserves had reached US$346.5 billion, a steep 63 percent higher than by the end of 2001.
Further, in 1994, China adopted a fixed exchange rate regime, in effect pegging the exchange rate at 8.28 yuan to US$1. Since early last year, the greenback has depreciated greatly vis-a-vis the major international currencies. From Jan. 1 last year to July 9, for example, the US dollar lost 28 percent of its value compared to the euro, 27 percent compared to the Indonesian rupiah, 12 percent compared to the South Korean won and the Japanese yen, and 7 percent compared to the Thai baht and the Singapore dollar.
Since the yuan is pegged to the US dollar, it has also depreciated by the same amount relative to these currencies. According to quantitative analysis by the American economist Zhang Xin (
Because China has accumulated a large balance of payments surplus while the yuan is seriously undervalued, many countries -- in particular, the US, Japan and the European countries -- began last year begun to pressure China to revalue the yuan. These countries believe that China's exchange rate regime leads to unfairness in international trade and that it allows China to dump its products at low prices, thus causing trade deficits and deflation in these countries.
Starting early this year, Japanese Finance Minister Masajuro Shiokawa has on several occasions asked various countries to join hands to force a revaluation of the yuan. The president of the European Central Bank and many finance ministers have also made clear requests that Beijing expand the yuan's floating range to let it appreciate to a more appropriate value.
Nevertheless, it is the US that is applying the most pressure on Beijing. Last year, the US' trade deficit with China reached US$103 billion. This led to a strong reaction from the US manufacturing sector and some politicians. As the next US presidential election is draws near, they are also pressing the Bush administration, claiming that China's low-priced products are creating a serious unemployment problem and that China is the main culprit behind the US' high trade deficit. Since June, Snow has repeatedly implied that the yuan should be allowed to appreciate.
China is also facing domestic pressures to revalue the yuan. Since last year, China has accumulated a large trade surplus, direct foreign investment and speculative "hot money," or money which is lent on a short-term basis. Last year, the Chinese balance-of-payments surplus reached US$74.2 billion. Foreign exchange reserves increased by US$60.1 billion from January to June this year, but more than US$20 billion of this money is probably short-term speculative hot money.
Over the last few months, the Bank of China has purchased US$600 million daily in order to stabilize the yuan. This has led to a rapid increase in the money supply -- during the first half of the year, the Bank of China increased the basic money supply by 387.6 billion yuan in order to stabilize the exchange rate. By end July, China's broad money supply, M2, stood at 20.6 trillion yuan, an increase by 20.7 percent over the same time last year, and a growth in the rate of increase by 6.3 percent compared to the same period last year.
The current rate of increase in M2 is already 11.9 percent higher than the rate of increase in GDP and the consumer price index. If this continues for long, China's economy will become overheated and a bubble economy will be created.
Although Beijing already has adopted several measures aimed at liberalizing trade and doing away with foreign exchange regulations to ease the pressures to revalue the yuan, it will probably still be difficult to alleviate strong international (particularly US) and domestic pressures for a revaluation.
The only way for China to maintain a managed floating exchange rate regime (in practice a fixed exchange rate) and to ease domestic and international pressures for revaluation, is to allow the yuan a wider floating range, thus allowing it to appreciate by a moderate amount, say, 3 percent to 5 percent.
Tung Chen-yuan is an associate research fellow at the Institute of International Relations at National Chengchi University.
Translated by Perry Svensson
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