Conceptions or misconceptions about China's exchange rate policy – Is the undervalued yuan indeed detrimental to the global economy as a whole?

Abstract

The international economic literature makes primarily China responsible for the evolution of a global disequilibrium. According to this view, China's current account surplus and the growth of the resulting Chinese official exchange reserves to almost two thousand billion dollars were rendered possible by holding the yuan at a low exchange rate. In this paper, I intend to highlight that the appreciation of the yuan, which began through American government pressure, did not push world economic processes to the direction of global correction. Appreciation, in the short run, leads to unleashing inflation and to further buildup of official exchange reserves. I shall demonstrate the above with the example of the Japanese economy in the 1970s. The appreciation, so often referred to, can only exert its effect in the long run. I shall also point out that foreign exchange rates have a direct impact on the balance of trade. Current account surplus merely reflects the extent of domestic saving exceeding domestic investments. How a discrete appreciation of China's currency will affect its current account surplus is neither obvious nor unambiguous. To sum up, I arrive at the conclusion that there is a need to put a stop to the crawling appreciation of the Chinese currency and to develop an exchange rate with a narrow currency band in order to ease world economic tensions.