（Songzuo Xiang's paper on OMFIF Bulletin, April 1, 2010)
Renmnbi revaluation debate leads in wrong directions:Monetary reform not scapegoat searching is the answer
By Songzuo Xiang
There is a great deal of noise – but not much illumination – about the renminbi exchange rate. The debate about the renminbi’s valuation would be a great deal more helpful if it was guided by a better understanding of the Chinese economy. Many arguments have been advanced since 2002 to press for a renminbi appreciation. Very few, however, have any solid theoretical rationale or empirical support. Imperfect or biased explanations have focused unwarranted blame on the renminbi exchange rate as the main cause of the shortcomings of the international monetary system This diverts attention from the real failures and from the opportunity to reform the system.
The most popular argument for a revaluation of the renmninbi is that it would help restore global economic equilibrium, which the US Treasury Department appears to define largely in terms of US trade deficits and balance of payments deficits. To my mind, that is a rather narrow definition. And it pays insufficient attention to the reality that, under the current dollar-dominated system, the core reserve-issuing country (that is, the US) must have balance of payments deficits in order to supply reserve money, just as South Africa under the Gold Standard had to have balance of payments deficits to allow gold exports.
We must remember that since the breakdown of Bretton Woods System in 1971, world foreign reserve assets have increased roughly 160-fold, from $45bn to $7.5trn, more than 70% of which has been supplied by US balance of payments deficits. Levels of dollar exchange rates, whether in the 1970s against the D-Mark, in the 1980s against the yen, or now against the renminbi, have very little to do with US deficits and so-called ‘global imbalances.’ If US officials say they should correct their deficits as a means of rebalancing the world economy, then the best way of achieving this would be to take steps to abandon dollar system and accept other currency or currencies as international reserve money.
The large Chinese trade and current account surpluses do of course deserve some attention. But it is imp
There appears to be a more plausible argument for renminbi appreciation, namely that the People’s Bank of China needs an ultimately flexible exchange rate policy and currency appreciation as a means of carrying out an independent monetary policy and controlling inflation. This argument rests on the celebrated thesis of the ‘impossible trinity,’ under a country cannot simultaneously run an independent monetary policy while maintaining exchange rate stability and unrestricted capital flows vis-à-vis the outside world. However, intensive empirical research on Chinese monetary developments since 2002 (including research by Peterson Institute for International Economics) has found no persuasive evidence of a relationship between renminbi appreciation and monetary independence. Moreover, the monetary experiences of many Asian and South American emerging economies since the 1980s (particularly after the Asian financial crisis of 1997-98) have quite often contradicted the view that exchange rates flexibility allows monetary independence.
Rather than going down false trails, we should learn the right lessons from the global financial crisis and mobilize forces to rethink and reform the international monetary system. I believe the asymmetry of the dollar-dominated monetary standard, and the fallacies associated floating exchange rates, are two fundamental reasons for recurrent financial crises and the phenomenon of global imbalances. There has been a sharp contrast between the relative financial stability of the Bretton Woods fixed exchange rates era and the extraordinary volatility of flexible exchange rates after the final breakdown of Bretton Woods in 1973. Although there were monetary crises between 1945 and 1971, these were confined on
The increasing politicization of the renminbi exchange rate and a search for scapegoats rather than solutions point us in the wrong direction. This mindset impairs prospects for world economic recovery. No-on
Member of Advisory Board, Official Monetary and Financial Institutions Forum(OMFIF)
Senior Fellow, Center for International Monetary Research, Renmin University of China