CHINA REVALUES YUAN: A TURNING POINT?

On July 21, 2005, after more than a decade of strictly pegging the renminbi to the U.S.
dollar at an exchange rate of 8.28, the People’s Bank of China (PBOC) announced a revaluation
of the currency and a reform of the exchange rate regime. This was the beginning
of a long-term strategy to integrate China into the world economy by easing the ability
of capital to flow into and out of the country. The ability to exchange currency is a
key factor in this process of integration. The revaluation signaled that China was beginning
to allow the strengthening of its currency. As of March 2007, the renminbi value
was at approximately 7.74. This means that it takes fewer renminbi (6 percent) to convert
to one dollar since revaluation. Many economic studies believe that a free-floating
Chinese currency would appreciate by 20 percent. Under the foreign exchange reform,
the PBOC incorporates a “reference basket” of currencies when choosing its target for
the renminbi. The five currencies are the U.S. dollar, the yuan, the yen, the Korean won,
and the pound. However, the exact weighting of these currencies in the basket is not
being disclosed and there may be other currencies included.
Even though the Chinese currency known as the renminbi does not float on the market,
and it is tied to the dollar within a narrow price, the influence of China on global
currency flows is profound. This limited managed float in effect is a subsidy for China’s
manufacturers and lowers the cost of Chinese goods, making competitor firms in the
United States and the rest of the world very upset with China. There is increasing pressure
on China to allow the renminbi to increase in value, either through a wider managed
envelope or through a full float. A full float is highly unlikely because the Chinese government
is not interested in giving up control of its economy, which would occur in a
full float. Any increase in the value of the renminbi could result in a significant benefit
to exporters in the United States and Japan. In recent years, even speculation that the
Chinese were about to allow the renminbi to increase in value led to price moves that
strengthened the Australian dollar and the yen.
China is becoming a global economic power that impacts the economic development
of the world. It is the processing plant of the world, wherein many product components
are imported and then put together. According to the Bank of New York, China’s top 10
trade partners (in dollars) are:
European Union (18.5 percent)
Japan (18 percent)
United States (17.5 percent)

Hong Kong (11 percent)
Association of Southeast Asian Nations (ASEAN) (11 percent)
South Korea (9.5 percent)
Taiwan (8.5 percent)
Russia (2 percent)
Australia (2 percent)
Canada (1.5 percent)
In looking at China’s top trading partners, we can see that China trade is spread out
among the world, with Europe, Japan, and the United States almost equally weighted.
But just over 40 percent of its trade is with Asia.
The importance of watching China’s economic conditions is highlighted by the following
remarks of U.S. Federal Reserve chairman Bernard Bernanke at the Chinese
Academy of Social Sciences (Beijing, China, December 15, 2006):
The emergence of China as a global economic power is one of the most important
developments of recent decades. For the past twenty years, the Chinese economy
has achieved a growth rate averaging nearly 10 percent per year, resulting in a
quintupling of output per person [see Figure 4.1]. In overall size, China’s economy
today ranks as the fourth largest in the world in terms of gross domestic product
(GDP) at current exchange rates, and the second largest when adjustments are
made for the differences in the domestic purchasing power of national currencies.




By ABE COFNAS