Barron's questions US support for floating yuan

According to Barron's (subscription required), it is unclear if the US is correct in suggesting that China 's
currency peg is what keeps the yuan undervalued in terms
of purchasing-power parity relative to the dollar. Furthermore, a floating currency would almost certainly not serve American strategic
interests. Here are the key points:

Virtually every emerging-market economy in the world has a substantially undervalued currency when measured by purchasing power:

• However, the reasons for emerging-market currency undervaluation are not fully understood.
• The only reasonable explanation presented is that currencies of developing countries carry risk premiums due to primitive capital markets (as is the case with China).
• In the developing countries that have relatively sophisticated financial systems, the degree of mispricing is much smaller than in those countries that lag behind in financial depth.

What does NOT explain undervalued currencies in emerging markets:

• Answer: Maintenance of a fixed-currency regime.
• Developing countries employ a plethora of currency regimes that range from free floats to currency boards. Yet all of their currencies remain undervalued when measured on a purchasing-power-parity basis.
• Hence, the US claim that the yuan is undervalued due to China 's fixed currency regime is questionable at best.
• It is far more likely that the yuan is "cheap" because China is at a relatively early stage of economic development.

Purchasing-power parity is not a very good explanation for current-account balances:

• Many "cheap-currency" developing countries have large current-account deficits.
• Meanwhile, Europe and Japan have large current-account surpluses with the US - yet their currencies are not particularly cheap.

Why China adopted a fixed-currency regime:

• To promote cross-border social and political integration.
• Using the same currency stimulates two-way trade and investment, helping to turn two separate economies into one integrated whole. This is the reasoning behind the euro.
• Could China be doing something similar? Barron's thinks so. China 's decision to link its currency to the dollar was motivated by a desire to maximize trade and investment with Hong Kong and Taiwan as part of its long-term strategy to integrate those entities into greater China.

Why a fixed currency is consistent with American interests:

• Integrated economies reduce the likelihood of military conflict between China and Taiwan, and should facilitate China 's gradual evolution from a belligerent communist state into a benign and prosperous democracy.
• By choosing the dollar peg as a vehicle for facilitating political integration of Taiwan and Hong Kong, China has assured that the US will enjoy a more or less permanent advantage over Europe and Japan in forging closer economic relations with China and Southeast Asia.
• Given current trends, this will greatly facilitate America's efforts to remain a prosperous global superpower.

As for the economic dislocations caused by the yuan's undervaluation:

• The US need not worry. China is printing yuan furiously, in order to buy up US dollars and defend its peg. The M-1 money supply rose by 19% over the past year. As a result, inflationary pressure is building in China. And inflation is just as effective a remedy for undervaluation as currency appreciation.

Comments

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I dont think US can do anything about that at this Point!

Jan 01 12:24 PM