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Special> Coping With the Global Financial Crisis> Expert's View
UPDATED: April 18, 2008 NO. 17 APR. 24, 2008
OBSERVER: Fast Yuan Rise Hurts China
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Chinese currency, the yuan, broke the 7 mark against the U.S. dollar on April 10. Till then, it had appreciated over 15.5 percent since China de-pegged the yuan from the U.S. dollar in July 2005. Its pace has picked up abruptly especially this year, and has risen about 4.27 percent since the beginning of this year. While calls for further appreciation continue from overseas, Deng Yuwen, a senior editor with Study Times affiliated to the Party School of the Central Committee of the Communist Party of China, shows his concern over its impact on the Chinese economy.

In 1971, amid downturns in the U.S. dollar, then U.S. Treasury Secretary John Connally told the rest of the world that the U.S. dollar was "our currency and your problem." Unfortunately, nearly 40 years later, China has become the latest entangled by the "dollar curse." What is left to China nowadays are diminishing export, shrinking foreign exchange (forex) reserves and bubbling inflationary pressures, and so on.

In the first quarter of 2008, the yuan appreciated about 4 percent against the U.S. dollar. If that pace continues, it would register a yearly appreciation rate of around 16 percent, far exceeding 6.9 percent of last year.

The past month has witnessed a 2.6-percent nosedive of the U.S. dollar against major global currencies. Supposing that the U.S. dollar takes a weight of 90 percent in China's forex reserves, $35.7 billion in reserves vanished in February, quadrupling its trade surplus of the same month, which was $8.55 billion.

Beside this, exchange losses brought about by the buoyant yuan have also begun to surface. The latest banking annual reports reveal that commercial banks including the Industrial and Commercial Bank of China, China Construction Bank and the Bank of China hold almost a combined $40 billion of forex assets exposed to risks. Calculated at an appreciation pace of 7.5 percent and the current exchange rate, these forex assets will sharply shrink by over 20 billion yuan ($2.9 billion).

China's forex reserves are fattened at the sacrifice of resources and cheap labor. But now its pains grow as nearly 300 billion yuan ($42.9 billion) of forex reserves and foreign currencies have evaporated so far.

Since the reform of the renminbi exchange rate regime in 2005, the yuan has mostly appreciated gradually. However, its pace picked up abruptly since the latter half of 2007 and particularly in 2008. Even the U.S. Treasury Secretary Paulson highlighted the yuan as "more flexible" on a recent visit to China.

Some economists and research institutions like international investment banks have been pushing for drastic appreciation of the yuan, which they believe can effectively moderate domestic inflation. But the fact runs contrary. What has come with the appreciation of the yuan is severe domestic price hike. Of course the snowstorm early this year is a factor, but not as big as price surges of international raw materials and excessive liquidity caused by continuous inflows of international hot money.

In theory, appreciation of a country's currency can help with its imports and alleviate inflation. But that is based on the condition that major global currencies the country's currency is pegged to do not suffer from substantial depreciation. For China the precondition does not currently exist. The U.S. dollar, one of the currencies the yuan has been pegged to, has been depreciating in recent years. Especially this year-the U.S. dollar fell 9 percent against the euro, hitting a quarterly record, and also weakened against the Japanese yen.

Dollar depreciation is obviously conducive to trim the trade deficit of the United States, but will also fuel bulging oil prices. As a large oil importer, China will no doubt be subjected to more inflationary risks as oil price hikes will directly jack up refined oil prices such as gasoline and heating oil. Furthermore, rocketing oil prices will also increase the production costs of enterprises and eventually force up prices of other products.

And it's not just oil that's undergoing price surges. Almost all commodities in the international market, especially raw materials, have become more expensive due to a cheaper dollar. For example, the price of iron ore has leapt 65 percent over last year. The rise of the yuan facilitates imports of more commodities, but in fact at higher prices. As a result, it can hardly offset the impact of domestic price inflation. As China becomes a global player influencing supply and demand in the global market, it will further strain global supplies to cushion the brunt from the international market through yuan appreciation. Worse still, international commodity prices will eventually creep higher.

Meanwhile, hot money is flooding the country on speculation of the rising yuan. Chinese central bank has to increase money supply, adding to excessive liquidity. Last year, China gained $461.9 billion of new forex reserves-$214.4 billion, or 40 percent higher over one year earlier. The first quarter of this year saw the forex reserves increase $60 billion, in which about $30 billion came from trade surplus and FDI (foreign direct investment). In my opinion, certain amount of the rest was international hot money betting on the rising yuan and leveraging the difference of interest rates between China and the United States. Last year, speculative money forced up almost all asset prices of the country and threatened to filter down to consumer products.

The above two factors will interact with each other and further aggravate the inflationary pressures facing China.

China's central bank has resorted to tighter monetary policies to curb inflation. But this round of inflation has been sparked by ballooning factor prices, including labor prices, which has defied the influence of interest rate hikes. Factor price hike may not necessarily subside, and enterprises may fall short of capital because of the tight monetary policies, and finally be put into a profit freefall. When tight monetary policies encroach on the productivity of enterprises, swelling production costs may at last lead to hyperinflation.

Since last November, the central bank has put a firm hand on bank lending. A handful of small and medium-sized enterprises have reportedly felt the pinch. Even competitive private enterprises in Jiangsu and Zhejiang provinces are having a hard time. And this is probably what the international floating capital is striving for. At first the yuan appreciation pushed up domestic factor prices, which then spilled out to consumer products, worsening domestic inflation. So a stringent credit clampdown had to be employed to tame inflation. But that could drag enterprises into recession and pare down their competitive edge in the international market.

As China, the world's fourth largest economy, increasingly globalizes, the yuan is bound to rise in value. But a cautious line is compelling in regard to how and by what margin. But as China's upgrade of its industrial structure stagnates, this leaves little technological edge for exporters to digest yuan appreciation. As a result, the yuan should by no means appreciate drastically.



 
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