Two factors have resulted in the appreciation of the yuan against U.S. dollar -- the yuan or Renminbi (RMB) is not convertible, and RMB has not yet become an international reserve currency. It is thus hard for China to raise its international purchasing power. Instead, the money pouring into China from abroad contributes to an excess of liquidity that causes a surge in prices, leading to the depreciation of the RMB for people in China's mainland.

The Renminbi, which closed at 7.2934 to the dollar in Shanghai trading as of January 2, 2008, has appreciated nearly 11.95 percent accumulatively, since China depegged it from the U.S. dollar in July 21, 2005. In the meantime, Chinese people at home are obviously feeling their purchase power declining, due to the hikes in many things, from meat and grain to equity and real estate.

The price index of commercial houses in June 2007, in 70 large and medium-sized cities nationwide, surged more than 7 percent compared with the same period the year before. The Consumer Price Index (CPI), an indicator of key inflation, climbed to a 11-year high of 6.9 percent in last November, mainly driven by soaring daily necessities.

According to the chief economist of the National Bureau of Statistics (NBS), China's trade surplus hit $238.1 billion from January to November, higher than the $177.5 billion recorded in 2006. The actual RMB depreciation at home will, to a certain degree, affect the country's financial stability negatively.

Money from overseas is likely to be attracted to China by an anticipated appreciation of the yuan and continued gains in the stock and real estate markets. The inflow of hot money into China's asset market is destined to help drive up the RMB exchange rate, leading to the rapid growth of domestic assets.

Since the U.S. greenback keeps a dormitory position in the price marking system for large commodities in international markets, the Chinese currency is not able to fend off international inflation with revaluation, and has to be a forced receptor of international inflation.

China is therefore not able to invest in the international market directly with the RMB or purchase required materials there. The country has to change its currency into the U.S. dollar or other convertible money to conduct international trades and investments. Its purchasing power was raised a little during the past two years when some prices of large commodities, represented by crude oil and copper, soared, affected by the weak U.S. currency.

To solve the problems of declining purchase power, and to bust the domestic asset bubble, according to experts, the Central Government should, first of all, adopt measures to streamline asset prices, elevate people's income levels, and increase export prices. At the same time, it should strengthen its supervision of the influx of speculated funds overseas, an important way to restrain the domestic asset bubble and prevent financial crises.

(Source: Shanghai Securities News)