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Why Overvaluing the Yuan Will Not Solve China's Inflation Problem [Copy link] 中文

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Post time 2013-8-12 07:17:02 |Display all floors
This post was edited by abramicus at 2013-8-12 07:21

There is a subtle and subconscious argument in academic circles that a high exchange rate for the yuan is needed to control inflation.  The basis for this theory is that export earning in dollars have to be exchanged for yuans by the domestic manufacturers on delivery of their goods abroad.  And these dollars, if converted to fewer yuans, would lead to less increase in the domestic money supply.  Lower money supply means, everything being equal, lower inflation rate.

This "logic" fails because the return trip of export revenues in dollars, when converted to yuans, actually extinguished debt incurred by the manufacturers in building their factories, in buying their raw materials, in paying for their daily operations, and extinguishing debt is the MAJOR use for these export revenues.  On the other hand, their failure to convert enough yuans from their export dollar revenues leads to persisting debt, if not ballooning debt, that runs the risk of eventual default if the dollar revenues they were getting, continue to be discounted at the PBOC currency exchange window.  Instead of getting say 7.00 yuans for every dollar of export earnings, they are now getting 6.12 yuans, leading to a shortfall of 0.88 yuans per dollar earned.  

The overvaluation of the yuan prevents manufacturers from clearing their inventories, as their products are overpriced in dollars abroad, and also overpriced at home.  This exacerbates their cash flow decline, due initially to the conversion of fewer yuans from their export dollar earnings.

The attempt to remedy the problem of inflation and decline in manufacturing by printing more money will not work, because all debts are unable to be paid due to incorrect pricing of dollars in relation to yuans by the PBOC.  It only creates more debt.  It encourages investment in fixed assets rather than in manufacturing enterprises.  Devoid of real net cash flow, all such investment end up being speculative bubbles.

The volume of yuans being created by the PBOC is about 10 trillion yuans.  The volume of trade balance surplus is about 200 billion dollars, or 1.2 trillion yuans.  Curbing the conversion of trade surplus dollars into yuans cannot cure inflation if the PBOC continues to issue yuans by an excess of 10 trillion yuans per year.  All the overvaluaation of the yuan will accomplish is to cause a decline in manufactured products, leading to scarcity of goods in the face of abundance of currency, fueling inflation, not curbing it.  How this simple logic can escape the top policy makers of China is hard to imagine.

The only difference is that when Deng started out on reforms, he acknowledged his imperfect understanding of economics, and the undependability of economic theories imported from abroad that serve the interests of the countries that preach them, and therefore, he always zhong zie jing yan, or consolidates experience, every quarter and every half year, to see if the results match the expectations of theory.  

Now, the captains of banking and economic policy think they undertand economics, and could trust the economic theories they had analyzed and learned, and fail to match reality with their expectations.  Instead of backing down on their damaging policies of overvaluing the yuan, they try to find other explanations for the damage that the overvalued yuan has done to the Chinese economy.  Its GDP continues to decelerate, and its PMI according to independent calculation by Markit for manufacturing, continues to dive.  Its pundits are like drowning men grasping at straws, and refuse to institute the cure of devaluing the Yuan back to 7.00 (the equilibrium exchange rate before Wall Street upset the apple cart with the collapse of Lehman Brothers), while trying every palliative measure they have in their repertoire, at grave cost to the Chinese manufacturing sector, and its growth trajectory, while benefiting its major foe, economically and militarily, Japan, through beefing up their dollar repatriations by billions each month, taken from the savings of the Chinese people in their foreign currency reserves.

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