It would be for China to peg the RMB to a basket of major currencies

Comments on Yu Yongding "China still has room to move on RMB" , 7/02/2016

While it is the conventional economic wisdom that the exchange rate should be determined by the market, the tendency of exchange rate overshooting and the generally observed excessive fluctuations (partially due to speculations) even in major currencies, as well as the impact of exchange rates on international trade and business costs (disruptions to businesses as either costs or prices) (consumption of traded goods and services should probably be included too), probably suggest that it would be desirable if exchange rate movements truly reflect relative economic fundamentals.

Economists' reliance on market is because it is regarded as efficient. However, the faith in the foreign exchange market should be tested by the relative importance of its rationality and irrationality. When market is predominantly irrational, that is, generating bubbles, its efficiency should be questioned, and perhaps ways to correct inefficiency or find a better alternative. If one still argues for rely on the market when the market has clearly lost its efficiency does not represent good logic.

As such, it would be an appropriate strategy for China to adopt a compromise between free floating and a hard peg to the US dollar, that is, to peg, with some margins to move, the RMB to a basket of major currencies with weight reflecting relative trade and capital account positions with those countries.

In this way, the RMB is not fixed with any major currencies, but the relative movement against any single major currency would be smaller than some other major currencies.

Yes, the Chinese central bank still needs to keep an eye on the peg and has to use foreign currency reserves to balance the peg, but the costs would be much lower than to defend a currency against the US dollar as it has been doing in the last couple of years as Yu mentioned in the post.

Optimism should be based on retionality and common sense

Comments on Jin Canrong “Reason for optimism in Sino-American relations”, 14/02/2010, http://www.eastasiaforum.org/2010/02/14/reason-for-optimism-in-sino-american-relations/

While issues related to human rights and Tibet will be a rhetorical topic between the two countries, they are unlikely to be real obstacles between optimistic and practical relationships between China and the US.

The issue of Taiwan, especially the US continual sales of arms to Taiwan, can become a more and more serious obstacle, and is likely to escalate further in the future as China becomes more confident internationally.

There are two more immediate big issues that are extremely challenging but there should be some practical ways to be resolved if common sense and rationality prevail on both sides.

They are climate change and exchange rates.

For the climate change issue, a rational solution is to adopt a fundamentally market based approach, that is, the principle of polluters pay at the world level, not just inside a country.

For the exchange rate issue, the difficulty lies in the huge Chinese official holdings of the US government bonds. The US has been demanding the Chinese to allow the RMB to appreciate. An appreciation not only affects trade flows, but will have a direct adverse impact on the value of the Chinese official holdings of those US government bonds.

This presents a real dilemma for the Chinese government, especially in an environment of increasingly domestic un-satisfaction over some reforms and rising inequality. Many young people, especially university graduates and students, are increasingly questioning some government policies. If some web opinions are a guide, allowing the RMB to appreciate would be regarded as devalue the Chinese assets, nothing short of treason behaviour.

The Chinese government is really caught between the strong pressure from the US and the increasingly dangerous domestic oppositions.

However, there should be some way out of this dilemma which may require the US to guarantee the real value in Chinese currency of the Chinese official holdings of the US government bonds. If an agreement is reached on that, then it will clear the main obstacles for some sort of decoupling of the Chinese and the US currencies.

So both issues are important and challenging. But there are reasons to be optimistic they can be resolved strategically, as long as common sense and rationality prevails.