Post-2005 Developments and Future Prospects

In undertaking a limited 2.1% revaluation of the renminbi against the dollar (to 8.11 RMB/$US) on July 21, 2005, the People’s Bank of China also referred to the adoption of a more “flexible” policy and of tying the renminbi to a “basket” of foreign currencies that would include the euro, the Japanese yen, and the Korean won in addition to the dollar.

Table 1.4. Correlations of the Renminbi with the US Dollar, Japanese Yen, Korean Won, and the Euro Before and After the July 2005 Regime Change

Sample Period: July 2005 to December 2006

Note: Each currency is defined relative to the Swiss franc, which serves as the numeraire for the comparisons.

Sources: Swiss National Bank (http://www.snb.ch) and the International Financial Statistics data­base.

dollar from 0.3% to 0.5% that took effect on May 21,2007. The rate of cur­rency appreciation had, of course, been lagging well behind the rapid rate of reserve buildup and expansion of China’s trade surplus. Although these latter factors are often cited as justification for much more drastic renminbi appreciation, past reserve inflows, to some extent, reflected “hot money” speculative flows. Allowing the currency to appreciate in face of such flows would validate revaluation expectations that may well have motivated the inflows in the first place, but would not necessarily be justified on any more fundamental basis. The size of China’s rapidly growing trade surplus, which reached 9.1% of China’s gross domestic product (GDP) in 2006, is certainly a concern and would seem to imply substantial renminbi undervaluation (cf. Goldstein, 2006; Roubini, 2007). Essentially the whole of this surplus has been derived from trade with the United States, however, and China ran close to a balanced trade position with the rest of the world in 2006 (and a substantial deficit in 2005). It is important, therefore, to look not just at possible imbalances on the Chinese side but also on the US side. As discussed in Chapter 2, while continued renminbi appreciation may indeed be warranted, extreme currency adjustment seems justified only if one takes the view that China is somehow responsible for correcting US and world imbalances single-handedly!