A Tortured Ascent?

Cover, issue no. 371 June 9 2008
Original article: [Chinese]

Since the beginning of the year, there has been intermittent news about the hardships faced by exporters due to slowed US economic growth and the faster appreciation of the yuan against dollar.

As China's economy slows down, it has become a widely-shared concern that if the yuan continues to appreciate, exports may decelerate even more greatly, which in turn will impact employment and economic growth. As a result, there have been suggestions that the yuan should stop appreciating. Some have even suggest it depreciate to retain China's export competitiveness.

Such views have gained strong support recently. At a June 2 International Monetary Conference, Federal Reserve chairman Ben Bernanke said that the collapse of the dollar and other currencies had contributed to an "unwelcome rise" in inflation. This comment was considered as a declaration of the US's determination to change the dollar's unfavorable position, which has emerged over the past few years.

To the understanding of those who are against yuan appreciation, a stronger yuan in the past was a result of a weak dollar, and now that the dollar will walk out of shadow, the yuan should stop appreciating or even depreciate against a stronger dollar.

In our opinion, the claim of Bernanke shouldn't be taken as the reason for changing the yuan's appreciation against dollar. On the contrary, it indicates a key point of the exchange rate mechanism, that is, to depress the yuan's value is unfeasible in the long run.

Depreciation of one's home currency has been a conventional measure to improve export competitiveness for many countries, such as China in the last two decades of the 20th century and the US in the past several years. A period of weak dollar policies has led to rapid growth in exports and a smaller export deficit for the US.

However, a weak dollar has also driven up the prices of imports, such as crude oil. As the dollar's purchasing power weakens the pressure of inflation mounts. This poses challenge to the Fed's tasks of stabilizing prices and maximizing employment, and meanwhile impels it to adjust its weak dollar policies.

For the following reasons, the yuan should not stop appreciating against the US dollar.

The process of yuan's progressive appreciation against the US dollar since July 21, 2005, is one aimed to gradually alleviate the undervaluation of the yuan. Today, the yuan is widely recognized as still undervalued against the US dollar. Thus, the process of the yuan's progressive appreciation is not over; likewise, international speculation on its appreciation will continue and intensify.

Yuan appreciation directly impacts China's exports to a certain degree, but how serious that impact is and whether or not it is the major force causing the bankruptcy of export-oriented businesses, remains unknown.

As we know from export-oriented businesses in Jiangzhe District, the most serious blow to their operations has come from the central bank's monetary and debt policies. Five interest rate bumps in the last year have increased their business costs. Moreover, the limitations on loans have made it difficult for them to secure credit, so they have turned to high-interest loans from underground banks. In addition, soaring fuel and raw material prices have also raised costs. These have had significantly larger impact than the yuan's appreciation.
In fact, rumors of the yuan's appreciation had been in a crescendo as early as 2003. If export-oriented businesses are still unable to deal with exchange rate fluctuations after so many years, their competitive edge is simply weak. One of the very objectives of the yuan's appreciation is to promote structural adjustments and increase businesses' competitiveness.

Certainly, the most important reason for the yuan's appreciation, and something which we have emphasized many times, is to curb inflation. It is inextricably linked to it.