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China's Exchange Rate and Financial Repression: The Conflicted Emergence of the RMB as an International Currency

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  • Ronald McKinnon
  • Gunther Schnabl

Abstract

Instability in the world dollar standard, as most recently manifested in the US Federal Reserve's near-zero interest rate policy, has caused consternation in emerging markets with naturally higher interest rates. China has been provoked into speeding RMB “internationalization”; that is, opening up domestic financial markets to reduce its dependence on the US dollar for invoicing trade and making international payments. However, despite rapid percentage growth in offshore financial markets in RMB, the Chinese authorities are essentially trapped into maintaining exchange controls (reinforced by financial repression in domestic interest rates) to avoid an avalanche of foreign capital inflows that would threaten inflation and asset price bubbles by driving nominal interest rates on RMB assets down further. Because a floating (appreciating) exchange rate could attract even more hot money inflows, the People's Bank of China should focus on keeping the yuan/dollar rate stable so as to encourage naturally high wage increases to help balance China's international competitiveness. However, further internationalization of the RMB, as with the proposed Shanghai pilot free trade zone, is best deferred until world interest rates rise to more normal levels.

Suggested Citation

  • Ronald McKinnon & Gunther Schnabl, 2014. "China's Exchange Rate and Financial Repression: The Conflicted Emergence of the RMB as an International Currency," China & World Economy, Institute of World Economics and Politics, Chinese Academy of Social Sciences, vol. 22(3), pages 1-35, July.
  • Handle: RePEc:bla:chinae:v:22:y:2014:i:3:p:1-35
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    File URL: http://hdl.handle.net/10.1111/j.1749-124X.2014.12066.x
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    References listed on IDEAS

    as
    1. Qiao, Hong, 2007. "Exchange rates and trade balances under the dollar standard," Journal of Policy Modeling, Elsevier, vol. 29(5), pages 765-782.
    2. Ronald McKinnon & Gunther Schnabl, 2012. "China and Its Dollar Exchange Rate: A Worldwide Stabilising Influence?," The World Economy, Wiley Blackwell, vol. 35(6), pages 667-693, June.
    3. Prasad, Eswar S. & Ye, Lei, 2011. "The renminbi’s role in the global monetary system," Proceedings, Federal Reserve Bank of San Francisco, issue Nov, pages 127-197.
    4. Ronald McKinnon & Gunther Schnabl, 2004. "The Return to Soft Dollar Pegging in East Asia: Mitigating Conflicted Virtue," International Finance, Wiley Blackwell, vol. 7(2), pages 169-201, July.
    5. McKinnon, Ronald I., 2013. "The Unloved Dollar Standard: From Bretton Woods to the Rise of China," OUP Catalogue, Oxford University Press, number 9780199937004.
    6. Gunther Schnabl, 2013. "The Macroeconomic Policy Challenges of Balance Sheet Recession: Lessons from Japan for the European Crisis," CESifo Working Paper Series 4249, CESifo Group Munich.
    7. Ronald McKinnon & Gunther Schnabl, 2006. "China's Exchange Rate and International Adjustment in Wages, Prices and Interest Rates: Japan Déjà Vu?," CESifo Economic Studies, CESifo, vol. 52(2), pages 276-303, June.
    8. McKinnon, Ronald I., 1979. "Money in International Exchange: The Convertible Currency System," OUP Catalogue, Oxford University Press, number 9780195024098.
    9. Ronald I. McKinnon & Kenichi Ohno, 1997. "Dollar and Yen: Resolving Economic Conflict between the United States and Japan," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262133350, January.
    10. John Whalley & Hejing Chen, 2013. "Are Offshore RMB Arrangements the Basis for a Long-term Exchange Rate System without Convertibility?," China & World Economy, Institute of World Economics and Politics, Chinese Academy of Social Sciences, vol. 21(1), pages 26-46, January.
    11. Ronald McKinnon & Gunther Schnabl, 2009. "The Case for Stabilizing China's Exchange Rate: Setting the Stage for Fiscal Expansion," China & World Economy, Institute of World Economics and Politics, Chinese Academy of Social Sciences, vol. 17(1), pages 1-32.
    12. Hung-Gay Fung & Jot Yau, 2012. "Chinese Offshore RMB Currency and Bond Markets: The Role of Hong Kong," China & World Economy, Institute of World Economics and Politics, Chinese Academy of Social Sciences, vol. 20(3), pages 107-122, May.
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    Cited by:

    1. Naoyuki Yoshino & Sahoko Kaji & Tamon Asonuma, 2014. "Dynamic Transition of Exchange Rate Regime in China," China & World Economy, Institute of World Economics and Politics, Chinese Academy of Social Sciences, vol. 22(3), pages 36-55, July.
    2. Hoffmann, Andreas & Schnabl, Gunther, 2016. "Monetary policies of industrial countries, emerging market credit cycles and feedback effects," Journal of Policy Modeling, Elsevier, vol. 38(5), pages 855-873.
    3. repec:bla:chinae:v:25:y:2017:i:1:p:32-57 is not listed on IDEAS
    4. Gunther Schnabl & Kristina Spantig, 2016. "(De)Stabilizing Exchange Rate Strategies In East Asian Monetary And Economic Integration," The Singapore Economic Review (SER), World Scientific Publishing Co. Pte. Ltd., vol. 61(02), pages 1-24, June.
    5. Gunther Schnabl, 2017. "Exchange Rate Regime, Financial Market Bubbles and Long-term Growth in China: Lessons from Japan," China & World Economy, Institute of World Economics and Politics, Chinese Academy of Social Sciences, vol. 25(1), pages 32-57, January.
    6. repec:agr:journl:v:1(614):y:2018:i:1(614):p:55-72 is not listed on IDEAS
    7. Andreas Hoffmann & Gunther Schnabl, 2014. "Monetary Policies of Large Industrialised Countries, Emerging Market Credit Cycles and Feedback Effects," CESifo Working Paper Series 4723, CESifo Group Munich.
    8. Yoshino, Naoyuki & Asonuma, Tamon, 2017. "Optimal Dynamic Path during the Transition of Exchange Rate Regime: Analysis of the People’s Republic of China (PRC), Malaysia, and Singapore," ADBI Working Papers 765, Asian Development Bank Institute.
    9. Tang, Bo, 2015. "Real exchange rate and economic growth in China: A cointegrated VAR approach," China Economic Review, Elsevier, vol. 34(C), pages 293-310.
    10. repec:spr:wirtsc:v:98:y:2018:i:7:d:10.1007_s10273-018-2322-7 is not listed on IDEAS

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