At the APEC summit, Chinese President Hu Jintao (
First, according to economist Frank Gunter's estimates, the total sum of capital leaving China between 1994 and 2001 reached US$69 billion, while in the period between 1997 and 2001, the sum was US$100 billion. This shows that there are big loopholes in China's capital controls. We can no longer define China as a closed economy, and must give full consideration to the relationship between China's domestic economy and the international economic situation.
From early January 2002 to early January this year, the US dollar lost approximately 40 percent of its value compared to the euro, 23 percent compared to the yen, and between five and 12 percent compared to the New Taiwan dollar, the Singaporean dollar and the South Korean won. From the beginning of this year to the middle of November, the US dollar continued to add between two to eight percent to these losses, and it seems it will continue to fall.
Because the yuan is pegged to the US dollar, its nominal value has fallen by the same amount as the US dollar compared to the above mentioned currencies. This is one very important factor behind the imbalance in the yuan's value.
In order to maintain exchange rate stability, China's central bank has been forced to buy more than US$10 billion per month since last year, and this has seriously affected the independence of its currency policies. The trend has continued this year, which has built strong pressure on the yuan to appreciate.
In the third quarter, China's central bank bought an average of US$14.6 billion per month, and the sum purchased in September was US$18.4 billion. The increase in interest rates by 0.27 percent will probably not be sufficient to cool down the overheating economy. Instead, it may add further pressure to appreciate the yuan.
In fact, the main reason China's money supply increased so sharply last year and this year, thereby creating domestic economic imbalances and overheating, was that foreign exchange reserves increased sharply.
Last year, the base currency increased by 748.8 billion yuan, and the total amount of foreign exchange transactions for the year contributed 91.5 percent of that increase.
For the first three quarters of this year, the base currency increased by 670 billion yuan, while the total amount of foreign exchange transactions for the year increased by 553 billion yuan (following write-offs on the open market), still contributing 82.6 percent of the increase in the base currency.
In addition, the US trade deficit with China is continuing to grow, and China is coming under heavy pressure from the US goverment to appropriately adjust the yuan. According to official US statistics, by the end of September, the US' trade deficit with China had reached US$114.4 billion, or 24.4 percent of the total US trade deficit, which was 27.5 percent higher than for the same period in the previous year.
The US treasury secretary has on several occassions requested that China implement a more flexible exchange rate system, causing increased market expectations for an appreciation of the yuan and a flow of hot money into China.
China's continuing economic overheating and the US dollar's continued fall have strengthened international market expectations for an appreciation of the yuan. For example, the discount on one-year yuan non-deliverable forward contracts (NDF, a "synthetic" forward contract on a non-convertible or thinly traded currency) has increased further, reaching 3,750 points on Nov. 6. This is a sign that the market expects the yuan to have appreciated by 4.6 percent one year from now. On Nov. 15, the discount for the same forward contract hit 4,000 points.
International institutional investors generally expect the yuan to appreciate in the short term. Citibank Group predicts that the yuan exchange rate will have increased by 3 to 5 percent to the US dollar by next spring; Merrill Lynch predicts an appreciation by 10 percent before the end of the year, and that there is room for a 20 percent appreciation; Morgan Stanley predicts an appreciation by 3 percent during the first half of next year, and by 7 percent by the end of next year; while Lehman Brothers predicts an appreciation by 5 percent in the coming quarters.
Based on the expectations on the yuan to appreciate, international speculative money continues to flow into China, constantly increasing the pressure on the yuan to appreciate to the point where there is no more room for apprecation. This is a self-fulfilling prophecy displaying the awesome power of international financial markets.
The yuan exchange rate has been imbalanced for three years, and this has led to a severely imbalanced and overheated Chinese economy. Unless China effectively stems the inflow of international speculative money, the adjustment to the yuan's exchange rate may occur within the next few months.
Tung Chen-yuan is an associate research fellow at the Institute of International Relations, National Chengchi University.
Translated by Perry Svensson
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