renminbi dollar bills STR/AFP/Getty Images

Releasing the Renminbi

China’s authorities are committed to advancing the shift toward a market-driven economy, with a fully flexible exchange-rate regime. That means that, while it can credibly commit not to keep the value of the renminbi artificially low, it must reject US demands to keep the exchange rate stable against the dollar.

BEIJING – The United States is reportedly pushing China to agree to keep the value of the renminbi stable, as part of a deal to end the trade war between the world’s two largest economies. It is a demand that China must think twice about before accepting.

The renminbi was undoubtedly undervalued for many years, including through a peg to the US dollar that was established in 1998. A undervalued renminbi was an important contributing factor to the trade surplus that China has run consistently since 1993, when its per capita income stood at just $400. In other words, even when China was a very poor country, it was exporting capital to the rest of the world, especially the US.

Though running a trade surplus benefits some sectors of the economy for some period of time, it is unclear that it benefits the economy as a whole in the long run. Still, two decades of maintaining a current-account surplus (which includes trade), together with a capital-account surplus (fueled by large inflows of foreign direct investment), enabled China to accumulate huge foreign-exchange reserves and a large stock of FDI. As a result, though China is one of the world’s largest creditors, it has run an investment-income deficit for more than a decade.

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