Hit the Brake
Inflation is back, and the Chinese economy has to cool down.
In short, substantial RMB appreciation would reduce the bilateral
US-China trade deficit and China's overall trade surplus significantly,
but it would do little to reduce the overall US trade deficit. In the
absence of a generalized appreciation of all Asian currencies and
unchanged American policies, possibly only a deep recession could
reduce the overall US current-account deficit. A stronger RMB can help
only the overheated Chinese economy. And it has the virtue of doing so
without hurting China's future production capacity.
How much is a «substantial appreciation»?
To curb future inflation, China therefore needs to stem the flood of capital.
One solution would be a large one-off appreciation of the yuan so
that investors no longer see it as a one-way bet. This, in turn, would
give the PBOC room to raise interest rates. The snag is that the yuan
would probably have to be wrenched perhaps 20% higher to alter
investors' expectations, and this is unacceptable to Chinese leaders,
especially when global demand has slowed and some exporters are already
being squeezed.This implies that monetary policy will remain too loose. The longer
that the torrent of hot money continues and interest rates remain too
low, the bigger the risk that underlying inflation will creep up.
Mark Trumball explains why Beijing, and not the US Federal Reserve, has to take the lead.
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