Talk from within China about the Appreciation of the Yuan

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Controls on the capital account are “virtually ineffective” and speculative funds keep pouring in, betting on the yuan’s appreciation, Guo Jianwei, a senior bank official for monetary policy, said in a policy paper. The report urges reform of the current exchange rate regime. The rate, set Wednesday at a record high of 7.4476 to the dollar, has appreciated faster in recent weeks, adding to already entrenched speculation that the yuan is a one-way bet.

“Worries that a narrowing US-China interest rate gap will exacerbate speculative capital inflows have limited the room for raising Chinese interest rates and have curtailed the strength of sterilisation operations,” he said.

The process of using interest rates to manage the economy has also become “ineffective” because of the sharp inflow of hot money and because of limitations in the interest rate regime itself, the report said.

One possible avenue for discouraging capital inflows is to further restrict the ability to take money out of the country, he said, a view that runs counter to suggestions that China needs to relax capital controls.

Robert Mundell, Nobel Prize Laureate in Economics, said China should learn lessons from Japan’s experience. The yen’s value tripled from 1985 to 1995, leading to a deflation that plagued the country for 15 years.

“Five percent a year will not be a great damage to Chinese economy, but be aware of the effect of accelerating it,” said Mundell.

A report compiled by the Institute of Urban Finance under the Industrial and Commercial Bank of China (ICBC) predicted the appreciation of the Chinese currency would accelerate.

The report published Wednesday on the China Securities Journal stated that a recent interest rate reduction in the United States had not hindered China’s prudent monetary policy for the time being, but over the long run the influx of liquidity into the country would quicken and cause the yuan to further appreciate.

Cheng Siwei, vice chairman of the Standing committee of the National People’s Congress, indicated that China should look at diversifying its $1.4 trillion in reserves into other stronger currencies

OTHER READING:
The Canadian dollar is hitting highs and has appreciated 27% in 2007 versus the US Dollar The Canadian dollar touched US$1.10.

In the middle of 2007, Canada had a GDP of C$1.53 trillion and a GDP growth rate of 2.3% per year Maintaining economic growth would put Canada at C$1.55 trillion at the end of 2007. This would convert to US$1.7 trillion for Canada’s GDP.

The United States GDP will at US$14.1 trillion at the end of 2007. (look at the top of table 3 in the long web [page)

China’s GDP at the end of 2007 is about 23.5 trillion yuan.

This is on track with my projection of China’s economy passing the United States in size on an exchange rated basis.

China’s overall is likely to pass the German economy on an exchange rated basis at the end of 2007 or very early in 2008. Any strong revaluation of the yuan with a strong appreciation could leapfrog China’s economy past Japan in 2008 or 2009.

UPDATE:
Brad Delong mentions that the primary risks to the global economy over the next two to three years is if China does not allow the Yuan to appreciate fast enough, which then results in a sharp unwinding in two to three years.