Posted by Dror Poleg on Saturday, April 9, 2005 at 5:36 PM
The official currency of the People's Republic of China (PRC) is Renminbi (meaning in Chinese: "people's currency"). The People's Bank of China, the PRC's monetary authority, issues the Chinese currency. The official ISO 4217 abbreviation of China's currency is CNY, but it is also abbreviated as "RMB". Colloquially, the Chinese currency is also called Yuan and Kuai.
During the previous decade, Mainland China's Currency was pegged to the U.S. dollar at 8.28 RMB. On July 21, 2005, it was revalued to 8.11 per U.S. dollar, following the removal of the peg to the U.S. dollar. The revaluation resulted from pressure from the United Stated and the World Economic Council.
The People's Bank of China also announced that the Renminbi would be pegged to a basket of foreign currencies, rather than being strictly tied to the U.S. dollar, and would trade within a narrow 0.3 percent band against this basket of currencies. China has stated that the basket is dominated by a group of international currencies including the U.S. dollar, euro, Japanese yen and South Korean won, with a smaller proportion made up of the British pound, Thai baht and Russian ruble.
History of Chinese Currency
The renminbi was first issued shortly before the takeover of the mainland by the Communists in 1949. One of the first tasks of the new communist government was to end the hyperinflation that had plagued China near the end of the Kuomintang era.
During the era of the command economy, the value of the RMB was set to unrealistic values in exchange with western currency and severe currency exchange rules were put in place. With the opening of the mainland Chinese economy in 1978, a dual track currency system was instituted, with renminbi usable only domestically, and with foreigners forced to use foreign exchange certificates. The unrealistic levels at which exchange rates were pegged led to a strong black market in currency transactions.
In the late 1980s and early 1990s, the PRC worked to make the RMB more convertible. Through the use of swap centers, the exchange rate was brought to realistic levels and the dual track currency system was abolished.
The RMB is convertible on current accounts, but not capital accounts. The ultimate goal has been to make the RMB fully convertible. However, partly in response to the Asian Financial Crisis of 1998, the PRC has been concerned that the mainland Chinese financial system would not be able to handle the potential rapid cross border movements of hot money, and as a result, as of 2003, full convertibility remains a distant goal.
Exchange rate of the American dollar vs. China's Currency (Renminbi)
From 1994 until July 2005, the policy on currency has been to peg informally the value of the renminbi against the value of the United States dollar. This policy was praised during the Asian financial crisis of 1998 as it prevented a round of competitive devaluations.
In 2003, this policy came under criticism by the United States. The fall in the value of the dollar caused the value of the renminbi to fall also, making mainland Chinese exports more competitive. This led to some pressure on the PRC from the United States to increase the value of the RMB in order to encourage imports and decrease exports. This is a policy that some feel would preserve manufacturing jobs in the United States. The G7 and European Union are also in favour of a re-evaluation of the exchange rate.
The PRC government has resisted pressure to increase the value of the RMB, out of concern that it would cause mainland Chinese jobs to disappear and would also expose domestic banks to currency risks that they are not prepared to handle. Many economists believe that only fixed exchange rates or floating exchange rates are stable over the long term, because a one-time change in exchange rates might cause speculators in the future to take positions on possible exchange rate fluctuations which would lead to pressure to completely float the currency.
The PRC government has also claimed that, while mainland China runs a large surplus with respect to the United States, its overall balance of payments is not out of balance.
Some independent analysts conclude that mainland Chinese currency is undervalued, because the People's Republic forbids citizens from moving their currency abroad. If this sort of financial diversification were allowed, the massive outflow of yuan could have a substantial effect on the currency.
Within the United States, the issue of appreciating the RMB is also controversial. Manufacturers and textile producers are in favor of appreciating the RMB. However, many American companies that depend on mainland Chinese factories to supply inexpensive products and components, such as aerospace companies, computer manufacturers, discount retailers, and other companies are against appreciating the RMB. Furthermore, many economists have pointed out that manufacturing jobs have been declining in the United States for decades. Some people have suggested that blaming the lack of job growth on the value of the RMB is merely a convenient misdirection on the part of the vested interests, including the George W. Bush administration, inefficient businesses, and labor unions fearful of competition.
Financial consequences of revaluating or floating China's Currency
The financial consequences of free valuation are complicated. Many economists believe that appreciation of the yuan would cause the PRC government to buy fewer United States treasury bonds, causing bond prices to fall and bond yields to rise, hampering improvement in the U.S. economy. The ensuing depreciation of the US dollar might price oil out of the reach of the American economy, causing stagflation, a collapse of US oil dependant industries, massive unemployment and other dire economic consequences.
However, the potential risk to global balances from mainland China's inflexible exchange rate would be more critical if the PRC relaxed its controls on short-term investment flows without first introducing exchange rate flexibility. This is because shifting exchange rates nullify expected profits from investment flows seeking to take advantage of higher interest rates in another country. Without flexibility, speculative flows could quickly become large, as they did during the Asian financial crisis, and threaten economic stability and orderly world trade.
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