Mundell: China should have a fixed exchange rate

Nobel-prize winning US economist says China should not bow to American pressure to allow its currency to appreciate.
Nobel Laureate economist Robert Mundell says China should fix its currency against the US dollar, in a move that would contradict growing international pressure for greater exchange rate flexibility.

Mundell, a Columbia University economics professor who won the Nobel prize in 1999, says US concerns over a growing trade deficit are ômisdirectedö, and that a fixed exchange rate is a ôviable monetary policyö for China.

Speaking at Asian InvestorÆs inaugural ôAsian Investment Summitö in Hong Kong, Mundell says adopting a ômore flexible exchange rateö - that appreciated considerably, say 25% - is not in ChinaÆs interest, and that it would bring about huge problems, including further destabilising a banking system beset by bad loans, cause deflation, increase unemployment, reduce net foreign investment and ultimately cut economic growth.

ôIt would drop the growth rate from the 9% or 10% itÆs putting on now to well below 5%,ö he says. ôAnd that would get the growth rate down to those dangerous levels that they got in 1989 and 1990, the years of the great dissent connected with Tiananmen Square.ö

He also dismissed growing US claims that appreciation of the renminbi would help solve a growing US current account deficit, arguing that it obeys a logic of its own. He points out that the US had mainly deficits when it was a debtor nation before World War I, surpluses as it built up a strong creditor position between 1915 and 1970, and has had deficits since the late 1970s, and only crossed over into being a growing debtor nation in the late 1980s.

China, he argues, has therefore not contributed to the current state of the US balance of payments. Instead, he says, the growing deficit has had more to do with international savings-investment behaviour based on demographic factors and the role of the dollar as the principal international currency.

The comments come despite growing US hopes that the renminbi will appreciate further to reduce the trade deficit between both countries, which last year stood at $201.6 billion. US officials claim China maintains an artificially weak exchange rate to boost exports.

Two US senators have even gone as far as to sponsor a bill that would impose a 27.5% tariff on all Chinese goods, the amount they claim the yuan is undervalued by.

In recent talks with US president George Bush, president Hu said China had already launched a reform of its renminbi policy, and that further steps would be taken to liberalise the exchange rate in the future.

More recently, amid signs that its economy is overheating, Beijing allowed the renminbi to strengthen and briefly trade below the psychologically important level of 8.0 to the dollar for the first time in 12 years. China originally ended its peg to the dollar on July 21 last year, but the currency hasnÆt risen more than 0.15% since, despite the central bank saying it would allow movement of up to 0.3%.

Mundell also says far more needed to be done to reduce the ôhundreds of billions of dollars-worth of non-performing loansö racked up by ChinaÆs banks û estimated by the IMF to be equivalent to 35% of the countryÆs annual GDP.

ôAuthorities in China injected $45 billion from their reserves into Bank of China and the China Construction Bank to get them through very successful IPOs,ö he says. ôWhile that may have shoared up their balance sheets, non-performing loans have continued to increase. This is a serious problem, and will become a bottleneck to the countryÆs growth if not resolved soon.ö

Closer to home, Mundell says Hong Kong will keep its peg to the US dollar to boost trade links with the worldÆs largest economy.
MundellÆs view contrasts with Goldman Sachs who forecast Hong Kong switching to a yuan peg in the ôdistant futureö. Hong KongÆs currency is allowed to trade in a band between 7.75 and 7.85 per US dollar.
ôThere is an argument that the Hong Kong dollar and the Chinese yuan should be linked," said Mundell. Still, ôHong Kong wouldn't move to a yuan peg until Chinese policymaking is clarified.ö
"The US is 30% of the worldÆs economy and China is only 4-5%, so thatÆs where the weight is,ö he says. ôLinking to the US dollar gives you access to that huge economy. I donÆt expect a change of the Hong-Kong-dollar peg.ö
The Hong Kong Monetary Authority has said recently that there is no need to change its exchange-rate policy, even should it reach parity with the yuan, a denomination of ChinaÆs currency, the renminbi.
Mundell was recognized in 1999 for his analysis of monetary and fiscal policy under different exchange rate regimes. He has advised the International Monetary Fund, the Federal Reserve Board, the US Treasury and governments throughout Europe and Latin America.
¬ Haymarket Media Limited. All rights reserved.
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