You are here: Home > Opinion > Editor's Pick

The RMB exchange rate and Sino-US ties

By Ding Yifan: 0 Comment(s)Print E-mail China.org.cn, May 4, 2014

Adjust font size:

China’s central bank has widened the floating band of the yuan against the US dollar from 1 percent to 2 percent, after the exchange rate fell for the first time in many years.

The development sparked a new round of US Congressional furor at China’s “currency manipulation” and the threat of trade sanctions surfaced once again.

[By Yang Yongliang/China.org.cn]

How large a bearing does the yuan’s exchange rate have on the Sino-US relationship? The question can be analyzed from three angles.

1. The history of exchange rate reform.

It has been a long time since China adopted a manageable floating RMB exchange rate regime but the floating range has been narrow. Over a fairly long period of time, the yuan was overvalued. The rate was 5.8 yuan to $1 in the 1980s. At that time, there was concern that the undervaluation of the yuan might lead to the flight of capital. To prevent that from happening, the government exercised a strict control over foreign currencies. Only two currencies were circulated in China at the time. One is the yuan, and the other is the RMB Foreign Exchange Certificate (FEC), the yuan’s surrogate exchangeable with foreign currencies. The yuan itself was not convertible, and the FEC was mainly used by foreigners.

As China had a planned economy at the time, a shortage of commodities was common. The FEC was endowed with the power to buy commodities in short supply at fair prices. That was a result of a scarcity of foreign currencies in China. That also accounts for why “export to earn foreign exchange” was once the most popular slogan of Chinese companies. To prevent the drain of foreign currencies, the government forced Chinese companies that had earned foreign currencies in overseas markets to convert their earnings into RMB immediately.

Due to the shortage of foreign currencies and the overvaluation of the yuan, the Chinese exchange rate against the dollar in the black market was much lower than the official rate; the former being 10 to one, with the latter being 5.8 to one.

The FEC was abrogated in early 1990s and the yuan-dollar exchange rate was set at a central parity of 8.7 to one. Soon, the trade of the dollar in the black market died down, indicating that the new official rate was accepted by the market.

A few years later, a financial crisis swept across Asia, with the currencies in China’s neighboring countries depreciating drastically. Facing the crisis, Beijing did not intend to fix the yuan’s exchange rate. However, China still decided to peg the yuan to the dollar in order to stabilize exchange rates in Asia and prevent the occurrence of a war among Asian currencies. The move demonstrated China’s sincerity in being a responsible member of the Asian community, but was seemingly overlooked by the international community who didn’t utter a single word of appreciation.

The practice of pegging the yuan with the dollar was not favorable for China’s economic development, as the Asian financial crisis occurred right at the time when the dollar was strong. In the late 1990s, IT bubbles inflated American stock markets, drawing a slew of foreign capital into the United States, which in turn pushed up the exchange rates of the dollar. The dollar-pegged yuan was thus overvalued. What is more, all of China’s neighboring countries had depreciated their currencies. These changes undoubtedly, at least in theory, caused a dramatic weakening of Chinese products’ competitiveness.

After the Asian crisis, the investment environment deteriorated in Southeast Asian countries because of the instability of their exchange rates. Many transnationals shifted their production to China. The stable exchange rates of the yuan became an attraction for the global giants to invest in China.

Follow China.org.cn on Twitter and Facebook to join the conversation.

1 2 Next