China’s New Currency Policy

The Chinese government may be about to let the renminbi-dollar exchange rate rise more rapidly in the coming months than it did during the past year. There are two fundamental reasons why the authorities might choose such a policy: reducing its portfolio risk and containing domestic inflation.

CAMBRIDGE – China’s government may be about to let the renminbi-dollar exchange rate rise more rapidly in the coming months than it did during the past year. The exchange rate was actually frozen during the financial crisis, but has been allowed to increase since the summer of 2010. In the past 12 months, the renminbi strengthened by 6% against the dollar, its reference currency.

A more rapid increase of the renminbi-dollar exchange rate would shrink China’s exports and increase its imports. It would also allow other Asian countries to let their currencies rise or expand their exports at the expense of Chinese producers. That might please China’s neighbors, but it would not appeal to Chinese producers. Why, then, might the Chinese authorities deliberately allow the renminbi to rise more rapidly?

There are two fundamental reasons why the Chinese government might choose such a policy: reducing its portfolio risk and containing domestic inflation.

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