Market demand can best set yuan’s true rate

By Zhang Bin Source:Global Times Published: 2018/1/16 20:23:40

Illustration: Luo Xuan/GT

Last year, the yuan appreciated by more than 6 percent, and it is important to understand the exchange-rate mechanism to interpret that appreciation. There are two key elements: one is supply and demand, in relation to the "countercyclical adjustment factor," the other is the basket of currencies used by China.

In 2017, supply and demand experienced significant changes, and capital outflows slid markedly. Supply and demand were relatively balanced, and the "countercyclical adjustment factor" had a stabilizing effect. These factors eased depreciation pressure on the yuan.

Meanwhile, the influence of the currency basket stood out. One simplified way to explain the basket currency is that the yuan will depreciate if the US dollar appreciates against other currencies, and vice versa.

There are multiple reasons for the US Dollar Index's weakening; for example, the eurozone economy performed much better than expected. Previously, there was anticipation that US President Donald Trump's policies would pump up the US Dollar Index. However, for the moment, that anticipation has been dashed. 

Trump's tax overhaul will not have a substantial positive influence on the US economy. For one thing, the tax cuts look larger than they are. Before the reform, the effective US corporate tax rate was not very high because of many deductions and tax credits. For another thing, tax cuts will put fiscal pressure on the US government, which may lead to higher taxes on some sectors eventually to stop the deficit from piling up.

Even if lower taxes mean higher profits for US companies, there is a question if those profits will be used on investment and job creation. US companies are never short of investment funds. It is expectations rather than financial constraints that lead corporations to make medium- or long-term investment plans.

This year, the yuan is likely to remain strong against the US dollar. More trade surpluses are expected in 2018, which will create stronger support for yuan appreciation. But under China's current foreign exchange rate mechanism, this reason alone is not enough to push up the yuan's value. The direction of US Dollar Index will have some influence as well.

The yuan's value and its movements should be left to the market. Supply and demand will determine the exchange rate. There are often people calling for depreciation of the yuan to ease pressure on exports. But does this really benefit the Chinese economy?

Depreciation will create other problems. An undervalued currency will draw resources into substitutes for trade and cause an imbalance in resource allocation.

If China depreciates its currency, other countries may try to follow. Most economies around the world have adopted floating exchange rates, where every party shoulders the same risks. Exchange rate manipulation is a way of gaining benefits at the expense of others.

Whether it involves resource allocation, macroeconomic stabilization or maintaining a fair international economic order, it is beneficial for China to let the market decide the exchange rate.

The value of the yuan is fundamentally related to the nation's economic development level. Compared with developed countries, the Chinese economy in general has enjoyed rapid growth, with fast improvement of income levels and productivity. Conditions in China picked up in many industries in 2017. Expectations for Chinese economic growth in 2018 are very optimistic, with a forecast of 6.7 percent, according to the World Bank. Therefore, it is reasonable for its currency to appreciate.

China should be pleased with the sustained appreciation of the yuan since the wealth of a nation is usually marked by the purchasing power of its currency. All countries that have experienced fast growth have relied on improving domestic productivity and currency appreciation. China should not be an exception.

The author is a research fellow with Institute of World Economics and Politics, Chinese Academy of Social Sciences.


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