Introduction
The upward pressure on the renminbi in the early twenty-first century arose in the midst of generalized dollar weakness. Sharp interest rate reductions by the US Federal Reserve after September 11,2001, coupled with mushrooming US current account deficits, were met by a decline in the value of the US dollar against most major world currencies from 2002 onwards.
Subsequent Federal Reserve rate hikes were insufficient to more than temporarily suspend the dollar downturn in 2005, and dollar depreciation quickly reaccelerated in the face of continued record US trade deficits and new Federal Reserve rate cutting initiated in the second half of 2007. Whereas a past major devaluation of the dollar in 1933-1934 has itself been seen as a key policy shift that permitted sufficient monetary expansion to reverse deflation pressures in the 1930s (Bernanke, 2002), its impact is remembered more negatively in China - where it put great pressure on the economy and induced a monetary regime change that facilitated an ultimately disastrous inflationary spiral (see Chapter 5). Dollar depreciation is certainly not an official goal today. However, so long as mounting trade deficits require the purchase of more and more foreign currency in exchange for US dollars, the Federal Reserve could only seek to offset the resulting downward pressure on the dollar by raising interest rates sufficiently to attract more demand for a high-yielding US currency. Such a high-interest rate strategy would threaten severe deflationary consequences, however, and doubts as to the Federal Reserve’s willingness to undertake such a step only underpin continued dollar weakness.This chapter discusses the recent pressure on the renminbi in light of US and global imbalances. The United States’ bilateral trade deficit is put in perspective with overall US and Chinese current account positions as well as the worldwide trend toward rising current account surpluses among emerging market economies.
Should surplus countries like China retreat from the large-scale dollar purchases that have helped finance the burgeoning US current account deficits, there would likely be not only an acceleration of the pace of dollar depreciation but also significant upward pressure on US interest and inflation rates. China’s 2007 creation of a sovereign wealth fund may well be the beginning of a move away from the prior practice of allocating most new reserve accumulation to US Treasuries. Meanwhile, as discussed later in this chapter, it does not seem likely that renminbi appreciation offers any viable hope of reining in US current account deficits. Even double-digit renminbi appreciation would almost certainly leave intact the worsening trend in the US current account position. However, drastic renminbi appreciation would pose considerable risks for China. Although assessment of post-Bretton Woods episodes of rapid currency appreciation in Japan and Taiwan does not yield an unambiguously negative perspective, these experiences raise concerns not only regarding the effects on investment and export performance but also the likelihood that, once begun, the appreciation process would end up overshooting any reasonable equilibrium exchange rate value. Given the very real questions surrounding current renminbi undervaluation, as discussed in Chapter 1, continued limits on the rate of currency adjustment may well be justifiable on economic grounds.
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