He Fan

 

The reform to China's exchange regime is being carried out in a market-orientated means toward a long-term target. Turing it into a political issue would only harm the process or even tarnish the ultimate target itself.

 

China's exchange regime is one of the major topics in the Strategic Economic Dialogue between China and the United States, which began in September 2006. The talks are only one indication of the US government's concern over China's exchange rate.

 

Before commenting on America's over-concern, it is necessary to examine the gains and losses of the US on the renminbi exchange rate issue.

 

Will the United States reap great benefit from a significant renminbi appreciation? Certainly not.

 

China will see reduced exports as a consequence of renminbi appreciation, but the US will not stop buying the necessities it requires. US importers may turn to other developing countries. But if the commodities from those countries are more expensive than Chinese goods, the switch does not improve the US's international balance by reducing its trade deficit.

 

If China loses its share of the international market for the yuan appreciation, its economic growth will be slowed, cutting down its imports from the US. It will not help reduce the US trade deficit, either.

 

Commodity trade aside, the renminbi's appreciation will also hurt the US in capital account items. US direct investment will become less rewarding after the yuan gains against the US dollar, decreasing US profit from international investment.

 

As a matter of fact, the US has more to gain if China maintains the renminbi at a stable level.

 

When the US manufacturers shift their factories into China for the relatively lower costs here, US customers still enjoy the products by importing them from China. The consumption of resources, energy and the pollution to the environment during the manufacturing process are all left in China.

 

When the yuan is stable, the US has a more important advantage.

 

Thanks to the trade surplus, China has accumulated a large sum of US dollars and its world largest foreign exchange reserve is mostly in US dollars. Such a big sum, a considerable portion of which is in the form of US treasury bonds, contributes a great deal to maintaining the position of the US dollar as an international currency.

 

Russia, Switzerland and several other countries have restructured their foreign exchange reserve and reduced the US dollars they hold. China is unlikely to follow suit as long as yuan's exchange rate is stable against the US dollar.

 

The Chinese central bank will be forced to sell US dollars once the renminbi appreciates dramatically, which might lead to a mass depreciation of the US dollar against other currencies.

 

The Chinese government launched an exchange reform regime years ago. The renminbi will be appreciated gradually, the exchange regime would evolve in a managed floating exchange rate system and an effective foreign currency market would be established.

 

China made such a choice because the former arrangement of pegging to the US dollar might weaken China's flexibility in monetary policies. And it has also realized that an undervalued yuan will slow the industrial restructuring and cause vicious competition among Chinese exporters.

 

However, this reform is only part of a much bigger effort to upgrade the country's industrial structure. The exchange regime is not going to finish the task single-handedly.

 

First of all, the exchange regime reform is not a solution to tackle China's trade surplus. China's exports are mainly propelled by the processing trade, which is not sensible to the exchange rate. Even if the renminbi does rise dramatically, the processing trade is not going to drop instantly and the trade surplus may not diminish. Figures from Japan and China's Taiwan Province, where the processing trade used to dominate, have also indicated a lasting surplus in the case of an appreciation of local currency.

 

The exchange regime's reform will not put the lopsided industrial structure into balance by itself. Theoretically, a changing rate would help promote the development of industries that are not trade-orientated, in China's case, the tertiary sector.

 

However, China's tertiary sector was fledgling for multiple reasons, including inadequate supply of qualified talent and underdeveloped infrastructure. Such factors are not easily improved by the exchange regime reform.

 

Therefore, an objective view about exchange regime reform is indispensable when people discuss the renminbi exchange rate.

 

The exchange rate equals a price between currencies in economic theories. Price is the key to allocating resources, which would bear remarkable significance for all resources in the market.

 

The Chinese government is determined to further this reform, but only according to its own blueprint. The greater target might be tarnished if the exchange regime reform is boiled down to the appreciation of renminbi. How much should the yuan be appreciated? How long will it rise? Similar questions should find their answers from the progress in related fields. No one can give definite answers before the progress is achieved.

 

It would be totally against the rule of the market economy when a country, through a political course, asks the Chinese government to change a key price in the economy. It is both unwise politically and unrealistic to ask China to realize the targets for its long-term reform in a short time.

 

The Strategic Economic Dialogue is a constructive innovation to eliminate bilateral misunderstanding, pinpoint the strategic issues of common concern and maximize the benefits of Sino-US cooperation. It may cost the chance of cooperation if the US insists on politicizing China's exchange regime reform and the political shortsighted doggedness will also lead to the neglect of more important issues.

 

The author is a researcher with the Institute of World Economics and Politics at the China Academy of Social Sciences

 

(China Daily August 7, 2007)