In July 2005, the Chinese government announced that it was changing its official exchange rate regime. As American politicians had been demanding, the yuan or renminbi would no longer be pegged to the dollar. Rather the authorities would:
(2) allow a margin of fluctuation in the exchange rate that, though small in any given day, could cumulate substantially over time.
The use of a new, more sophisticated, statistical equation reveals that during the course of 2007 the anchoring basket began for the first time to assign substantial weight to the euro. For a period that ran up to approximately May 2008, the anchor was a true basket that put virtually as much weight on the euro as on the dollar. There was also some limited flexibility around that anchor. When high or low international flows were working to push the currency away from the basket, the authorities would intervene, or “lean against the wind,” to push the currency back. [Frankel, 2009, forthcoming in Pacific Economic Review.])
De facto regime of RMB: 100% weight on $ ↓Some weight on won↓½ weight on $ + ½ on € ↓ ↓100% weight on $
The recent link to the dollar is visible in the flattening of the magneta line at the end. What has been the implication of the movement back toward a dollar peg over the last year? It has been to strengthen the RMB above what it would be if Beijing had stuck with the regime of 2007. Why? Because over the last year, the dollar has appreciated strongly against the euro. If the RMB had stuck with the basket peg in 2008 and 2009, it would have depreciated against the dollar (because the euro depreciated) by an estimated 14%. This would have been the opposite of what congressmen really want!
It is interesting to speculate why the Chinese monetary authorities have moved back to the dollar during the period when the US recession has worsened and gone truly global. One possibility is that the dollar feels like a security blanket to them, and its familiarity in time of crisis trumps the desire to maximize their price competitiveness on world markets. A more likely explanation is that they switched to a dollar peg sometime in 2008 because they expected that the dollar would continue to depreciate as it had in preceding years – a forecast that would not have sounded entirely unreasonable at the time, given that the financial crisis originated in the United States, on top of the preceding seven-year trend depreciation. If that is the answer, it is likely that the regime will change once again before long. But American politicians might want to think twice before demanding that the RMB abandon its link to the dollar.
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