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UPDATED: May 2, 2014 NO. 18 MAY 1, 2014
Those in Glass Houses Should Not Throw Stones
By Lan Xinzhen

It has been reported by Western media that an official from the U.S. Department of the Treasury said that the recent depreciation of the Chinese yuan could raise "serious concerns" if it signaled a policy shift away from allowing market-determined exchange rates. Such concerns are somewhat obscure. We can see that he does not regard the yuan exchange rate fairly based on the rules governing market economies.

China started its second round of exchange rate reform in July 2005. The yuan was no longer pegged to the U.S. dollar but to a package of currencies. As the exchange rate reform advanced, the yuan appreciated unilaterally. From July 2005 to the end of 2013, the yuan's exchange rate against the U.S. dollar rose 35.7 percent. When the United States first adopted its quantitative easing policy as a response to the 2008 global financial crisis, the yuan still continued to appreciate at a time when other currencies were depreciating significantly against the U.S. dollar.

The unilateral appreciation of the yuan imposes great pressure on the Chinese economy. For example, in times of currency appreciation, the competitiveness of export-oriented companies is generally impaired, and many even go bankrupt. In addition, a huge amount of hot money has come to China from other countries because of speculation regarding yuan appreciation, pushing up asset prices and causing imported inflation in China.

For reasons associated with unstable economic growth, the market is now concerned about risks that the Chinese economy may decline. Furthermore, because of the fact that the United States is withdrawing its quantitative easing measures and the consequent expectations of a U.S. dollar interest rate hike, the unilateral appreciation of the yuan ended this year.

Exchange rates go up as well as down. This is a market phenomenon. However, after the yuan recently depreciated, certain U.S. official expressed "concerns" in so timely a manner that people naturally cast doubts on his intentions. The official also said the United States was not completely sold on China's intention to reduce authorities' interventions in exchange markets. He went on to note that China has made "considerable interventions" in exchange markets and that is exactly the sort of behavior Washington wants Beijing to ditch.

By this logic, if the yuan appreciates, it is market-oriented behavior, and if the yuan depreciates, it is because of government intervention. This is a very irrational position.

In the context of domestic and international conditions, the yuan's depreciation has met expectations. According to the February figures from the People's Bank of China, the country's central bank, the newly added funds outstanding for foreign exchange declined to 128.2 billion yuan ($20.81 billion) from 437.3 billion yuan ($70.99 billion) in January. It is clear that international capital is fleeing so as to avoid the risks of possible economic decline in China, a major reason for the recent yuan depreciation. If Chinese economic performance improves, the yuan will resume appreciation. The facts will scotch the rumor that "considerable intervention" caused the depreciation of the yuan.

On the other hand, according to the International Monetary Fund, currency intervention is a valid instrument for central banks of emerging markets to use alongside interest rates. The United States also intervenes in the foreign exchange market, and sometimes it even cooperates with other countries to conduct currency intervention.

In March, the central bank widened the yuan's trading band, indicating China's determination to liberalize its exchange rate. However, the nation also needs to strike down speculators betting on the yuan's appreciation, and prepare to further widen the trading band of the currency. Such intervention meets market demand.

A free exchange rate of yuan is a major goal of China's financial reform. The nation vowed to allow the market to play a decisive role in the allocation of resources. The exchange rate serves as one of the decisive factors in the allocation of both domestic and international resources. As market-oriented reform advances, the yuan exchange rate will mainly be decided by the market in the future, and the central bank's role will be weakened. Just like other major international currencies, the yuan will be given room for two-way fluctuation. Therefore, all market participants should regard fluctuations of the yuan exchange rate more reasonably.

Email us at: lanxinzhen@bjreview.com

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