An alternative approach to the pressure to appreciate the Yuan

Okay now the whole advanced world seems to be unanimous in attacking the manipulation of the exchange rate of the Renminbi, how much longer can the Beijing government withstand this pressure? It seems that eventually China will have no choice but to free the trade of Yuan and see it appreciate. But does it have to be so?

Exactly two years ago China began to release it’s 4-trillion-yuan stimulus package; that is roughly 603.86 billion U.S. dollars, or more than a tenth of China’s GDP in 2008 ($4.33 Trillion US dollars at current prices). Yes, China is one of the most successful in overcoming the late financial crises, but that is achieved at a cost. Housing price skyrocketed, with house-price-to-income ratio as high as 164, and we are witnessing the 17^th straight increase in property price; CPI has risen to a 25-month high in October; food alone rose 10% from a year earlier.

Besides giving up manipulation over its currency, China may be litmus-testing an alternative approach: lowering the real value of the Yuan by gradual but continued inflation. Four years ago when I first came to Hong Kong, consumer prices was still about twice those in Beijing; but last summer when I went back to Beijing, prices were already comparable to those in Hong Kong in many categories, if not most. While the CNY-USD exchange rate has been quite stable in the past two years (until recently), the true purchasing power seems to be depreciating throughout the years (this I based on personal experience but not official data). It is now quite reasonable to expect banknotes with 500- and 1,000-yuan denominations to be out in the market in the near future.

With such continued effort, the Beijing administration may well depreciate the value of the Yuan to a level consistent with or much closer to the pegged exchange rate before unleashing the Yuan exchange market, while earning a huge amount of seigniorage revenue from thin air.

Sources:

CNTV.cn. (2010, November 10). China Winds Down Stimulus Efforts. Retrieved November 11, 2010, from Beijing Review: http://bjreview.com.cn/special/2010-11/10/content_311065.htm

Global Property Guide. (n.d.). House Price to Income Ratio - China Compared to Continent. Retrieved November 11, 2010, from Global Property Guide: http://www.globalpropertyguide.com/Asia/China/price-gdp-per-cap

Google. (n.d.). Gross Domestic Product. Retrieved November 11, 2010, from Google: http://www.google.com/publicdata?ds=wb-wdi&met=ny_gdp_mktp_cd&idim=country:CHN&dl=en&hl=en&q=gdp+china

Pierson, D. (2010, November 10). China's inflation rate hits 25-month high. Retrieved November 11, 2010, from Los Angeles Times: http://articles.latimes.com/2010/nov/10/business/la-fi-china-inflation-20101111

RRT Staff Writer. (2010, November 10). China Property Price Growth Cools In October. Retrieved November 11, 2010, from RTT News: http://www.rttnews.com/Content/AsianEconomicNews.aspx?Id=1475327&SM=1

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