The Renminbi Exchange Rate in the Increasingly Open Economy of China: A Long-Term Strategy and a Short-Term Solution

Abstract

This paper begins by providing two theoretical perspectives on the Renminbi (RMB) exchange rate issue: the principle of the impossible trinity and the self-fulfilling balance-of-payments crises models. Based on these theoretical perspectives, the paper elaborates on China`s external and internal economic imbalances. Finally, the paper argues that a practical approach for the Chinese government to consider would be to allow the RMB to appreciate by 10 percent by early 2007, to expand the floating band of the RMB exchange rate from ± 0.3 percent to 5-7 percent, and to maintain central parity based on a new RMB rate until it is again in disequilibrium by a wide margin. \r\nNevertheless, there is no timetable for an adjustment of the RMB exchange rate as long as the Chinese government can tolerate the expanding economic bubble, escalating financial risks, and foreign political pressure resulting from the undervalued RMB. However as long as China`s economy remains overheated and expectations of a RMB revaluation persist, the awesome power of the international financial market will most likely create a `self-fulfilling prophecy` of RMB appreciation in the future.