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Asia Times Online - Part 1 - Follies of Fiddling With the Yuan - Flawed Global Economics

Asia Times Online - Part 1 - Follies of Fiddling With the Yuan - Flawed Global Economics

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Published by dreamwvr
(explains economic history of several countries that allowed/adopted dollar hegemony, plus describes and predicts current economic bubbles). Dollar hegemony enables the US to be the only exception from macroeconomic penalties of unsynchronized exchange rates and interest rates. The US, because of dollar hegemony, is the only country that can claim that a strong currency that leads to trade deficits is in its national interest in a global economy dominated by international trade. This is because a strong dollar backed by high interest rates helps produce a US capital account surplus to finance its trade deficit.
(explains economic history of several countries that allowed/adopted dollar hegemony, plus describes and predicts current economic bubbles). Dollar hegemony enables the US to be the only exception from macroeconomic penalties of unsynchronized exchange rates and interest rates. The US, because of dollar hegemony, is the only country that can claim that a strong currency that leads to trade deficits is in its national interest in a global economy dominated by international trade. This is because a strong dollar backed by high interest rates helps produce a US capital account surplus to finance its trade deficit.

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2/15/2014Asia Times Online - News from greater China; Hong Kong and Taiwanhttp://www.atimes.com/atimes/China/FJ23Ad06.html1/18
PART 1: Follies of fiddling with the yuan
By Henry C K Liu Dollar hegemony emerged after 1971 from the peculiar phenomenonof a fiat dollar not backed by gold or any other species of value,continuing to assume the status of the world's main reservecurrency because of the US's geopolitical supremacy. Suchcurrency hegemony has become a key dysfunctionality in theinternational finance architecture driving the unregulated globalfinancial markets in the past two decades. China's overheatedeconomy is the resultof hot money inflowcaused by dollar hegemony. China'sdeveloping economyshould be able toabsorb huge amountsof capital inflow, but dollar hegemony limits foreign investment to only the Chinese export sector, where dollar revenue can be earned to repay capital denominated in dollars. Since China's export sector  cannot grow faster than the import demands of other nations,excessive dollar capital inflow overheats the export and exported-related sectors, while other sectors of the Chinese economy suffer acute capital shortage. Overheated economies produce growth-inhibiting inflation throughexcessive import of money and sudden rises in prices for importedcommodities and energy. The imported inflation is then re-exported,causing inflation in other parts of the global economy. Inflationcauses interest rates to rise, which in turn causes unemploymentand recession in all economies that are plagued by it. China's currency, known as the renminbi (RMB) yuan, has beenpegged to a fiat dollar within a narrow band (0.3%) around an officialrate of 8.28 to 1 since 1995. Even though the yuan is still notentirely freely convertible, any change in dollar interest rates willimpact yuan interest rates due to the peg. While the linkage between exchange rate and interest rate is direct,the exchange rate policies of most countries do not always operatein sync with their interest rate policies, leading to imbalance anddisequilibrium in their economies. This is because these two relatedpolicies impact different segments of the population differently. Thusconflicting political dynamics push them in conflicting directions. Capital generally prefers a strong currency since it reflects financialstrength, while labor prefers a weak currency to boost exports that 
Search Asia Times
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Oct 23, 2004
BEST OFHENRY C K LIUFed's pugnaciouspolicies hurteconomies 
(Jan10, '04)
  America'sselective strongdollar policy
 China vs thealmighty dollar
(Jul 23, '02)
 US dollar hegemony hasgot to go 
(Apr 11,'02)
 
2/15/2014Asia Times Online - News from greater China; Hong Kong and Taiwanhttp://www.atimes.com/atimes/China/FJ23Ad06.html2/18
 . better returns while labor prefers low interest rates for cheaper consumer loans and affordable mortgages. China will be noexception as its moves toward interest rate liberalization and freecurrency conversion. Dollar hegemony enables the US to be the only exception frommacroeconomic penalties of unsynchronized exchange rates andinterest rates. The US, because of dollar hegemony, is the onlycountry that can claim that a strong currency that leads to tradedeficits is in its national interest in a global economy dominated byinternational trade. This is because a strong dollar backed by highinterest rates helps produce a US capital account surplus to financeits trade deficit. While other economies must earn dollars to finance their dollar deficits, US trade and fiscal deficits need only be repaid with dollarsthat the US can print at will, not from dollars that the US must earn.That in essence is the benefit of dollar hegemony to the dollar economy. But while dollar hegemony is good for the dollar economy, it imposes costs of job loss and a debt bubble on the USeconomy.
Off the dollar, and back
China's exchange rate policy is not always synchronized with itsinterest rate policy. Currency control has protected China fromsevere macroeconomic penalties so far. On the exchange rate side,China has changed the exchange value of the yuan many timessince its introduction on January 1, 1970, when currency reformsubstituted 10,000 renminpiao for one RMB yuan fixed at an officialrate of 2.46 yuan to a dollar. After the collapse in 1971 of theBretton Woods regime of fixed exchange rates based on a gold-backed dollar, pressure grew to appreciate the yuan against afloating dollar no longer backed by gold. With the RMB's theoreticalgold content unaltered, a new official rate was set on December 23,1971 at 2.26 yuan to a dollar. The alarming free fall of the dollar ledChina to tie the yuan to the Hong Kong dollar and the British poundsterling. Hong Kong shifted from a rule-based currency board to adiscretionary currency board over the course of its monetaryhistory. From 1935 to 1967, Hong Kong as a British colonyoperated a classic colonial currency board pegged to the poundsterling, except that private banks - not the government - issued thecurrency, a practice that continues to this day. Instability in thevalue of the pound in the late 1960s pushed Hong Kong to switch toa dollar peg. The dollar, too, came under speculative attack after 1971. To avoid sinking with the dollar, Hong Kong also decided tolet its own currency float. It worked reasonably well until thecommencement of Sino-British negotiations on the return of HongKong to China, which unleashed wild speculation against the HongKong dollar, pushing the free-floating exchange rate temporarily to9.6 to 1 on September 24, 1983. By the end of October 1983, Hong Kong had ended its brief experiment with floating exchange rates and announced that it waspegging its currency to the dollar at a rate of 7.8 to $1 with adiscretionary currency board regime. The peg amounted to anofficial devaluation from the pre-crisis floating market rate of 4.6 to 1to defuse market panic. In 1985, two years after the adoption of theHK peg, the Plaza Accord, aiming to halt the rising US trade deficit,pushed the already steadily falling dollar sharply further downagainst the yen. The Hong Kong peg produced a sharplyundervalued Hong Kong currency that in turn gave birth to a bubbleeconomy that burst 12 years later in 1997 as part of the Asian
 
2/15/2014Asia Times Online - News from greater China; Hong Kong and Taiwanhttp://www.atimes.com/atimes/China/FJ23Ad06.html3/18
 financial crisis.
The independent yuan
In April 1972, with the Hong Kong currency free floating, Chinabegan listing an official effective rate for the yuan independent of theHong Kong currency. On August 19, 1974, the effective rate of theyuan was pegged to a trade-weighted basket of 15 currencies, thecomposition of which was undisclosed to the market. The effectiverate was fixed almost daily to the floating market value of thatbasket. By December 31, 1979, the yuan's effective rate rose to 1.5to a dollar when the US Federal Reserve under Paul Volcker mounted its heroic struggle to halt US inflation by raising dollar interest rates to historical heights. On January 5, 1980, the State Council issued a decree prohibitingpayments in foreign exchange within China. On April 1, 1980,Foreign Exchange Certificates (FEC), or
waihuijuan
, equal in valueto the yuan at the effective rate, were put into circulation, issued tonon-residents in exchange for designated hard currencies, for paying hotel bills, transportation fares and for purchases atFriendship Stores. Consumer prices were set at separate levels for the yuan and the FEC to reflect purchasing power disparity betweenthe two currencies. On January 1, 1981, a foreign trade rate with two categories wasintroduced for the RMB. For internal settlements under the foreignexchange allotment quota, the official rate was set at 2.80 yuan per dollar. This rate was formed by adding to the effective rate an"equalization price" for balancing export and import profits andlosses, and applied to all national enterprises and corporationsengaged in foreign trade as well as to receipts and expenditures inforeign exchange for trade-related transactions in invisibles such asshipping and insurance.  An experimental trading system for foreign exchange wasestablished by the Bank of China in a few areas such as Beijing,Guangdong, Shanghai and Tianjin. A foreign exchange retentionquota also permitted exporters to retain a portion of export earnings.National enterprises holding foreign exchange earned through thesystem of retention quotas were permitted to sell this foreignexchange to other national enterprises that had a quota for spending foreign exchange. For dealings under the foreignexchange retention scheme, the Bank of China acted as anexclusive broker, charging 0.1%-0.3%, resulting in an effective rateof 2.803-2.808 yuan per dollar. The effective rate was applicable toall other transactions, while the official rate was largely symbolic. On January 1, 1985, the internal settlement official rate wasabolished and all trade was governed by the effective rate. OnNovember 20, 1985, authorization was granted for residents to holdforeign exchange and open foreign exchange accounts and todeposit and withdraw funds in foreign exchange. This was to serveresidents who might receive foreign currency funds from relativesand friends overseas, as individuals generally did not havepermission to engage in foreign trade to earn foreign currency. Bythe end of November 1985, the yuan, pegged to a trade-weightedbasket of currencies, was trading at 3.2 to a dollar as a result of theLourve Accord that pushed the dollar up from the downwardovershoot of the Plaza Accord two years earlier. On January 1,1986, the trade-weighted basket of currencies peg was abandonedand the effective rate was placed on a controlled float based ondevelopments in the balance of payments and in inflation trends andexchange rates of China's major trading partners and competitors.

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