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When Should China Float?

Under heavy pressure from America, China's leaders have agreed in principle to float the renminbi, but refuse to say when. A floating currency is inevitable as China liberalizes its capital market and eliminates restrictions on international capital movements; otherwise, China would have to surrender control over its money supply and interest rates to the US. Yet China's rulers are right to postpone the decision to float.

The Chinese can delay, but they can't hide from a fundamental economic law: if the exchange rate between the currencies of two countries is fixed and capital flows between them are unrestricted, the economically dominant one will exercise control over the monetary policy of the other. Because the dollar is the dominant world reserve currency, and America's Fed controls the supply of US dollars, as long as China sticks to a fixed exchange rate, it cannot control its own money supply.