Chinese Currency

1. History

The Chinese government introduced its first exchange rate policy in 1949. From 1949 to 1955, the policy was based on a managed currency floating system. With the establishment of a centrally planned economy, the Chinese government implemented a pegged policy in 1955. After the collapse of Bretton WoodЎЇs system in the early 1970s, China changed its monetary policy to basket currency. The weak economic environment in the country in 1985 resulted in the re-introduction of the managed currency floating system. Between 1985 and 1995, the changes in the Chinese domestic finance and economy led to a rather drastic depreciation of RMB. The Chinese government reverted back to pegging its currency to the US dollar. The peg rate was approximately $8.28 RMB to $1 US in 1995. It was not until 2005 that the Chinese and US currencies were Ў°un-peggedЎ±, that is, RMB will be able to reflect based on its fair value.

2. ChinaЎЇs growing economy

Since the economic reforms in 1979, China became one of the fastest growing countries in the world. With the expansion of trade in the world market, exports increased to $593 billion in 2004, and imports increased to $561 billion in 2004. As a result, it leads to a trade surplus. In the last year, the trade surplus achieved more than $30 billion. Foreign direct investment in China has grown rapidly from $636 million in 1983 to $64 billion in 2004. Furthermore, the increase in exports leads to a trading surplus and the ChinaЎЇs foreign exchange reserve reached a new record at the end of 2004 at US$609.9 billion

3. Pressure

Some US economists believe that the reason for RMB to be pegged with the U.S dollar is to encourage the export of Chinese goods. Furthermore, these economists also believe that RMB is currently undervalued and the pegged exchange rate policy is a result of the large trading deficit in the US over the last couple of years. On July 21, 2005, intense pressure lead to the announcement by Chinese government that RMB appreciated 2.1%.

4. Controversies

Almost all of the controversial issues surrounding RMB are based on one assumption: the RMB is highly undervalued against US dollar. U.S. congress and government think the RMB is undervalued by as high as 50%. Is the RMB undervalued and if it is, by how much?

The most common method we use for hundreds of years is Purchasing Power Parity (PPP). Chu of GM had developed a different PPP index called Ў°Shef indexЎ±, which includes four basic materials and services: Salt, Haircut, Electricity and Flour. He argued that it may be more suitable to developing countryЎЇs