Americans are again clamouring for a rise in the renminbi. First, the moral argument: keeping the currency pegged at about 6.83 to the dollar lends Chinese exporters an unfair advantage, critics argue, increasing the Chinese trade surplus. Second, the pragmatic argument: China will have to let the yuan appreciate to combat inflation.
Today, the counter-arguments.
First, Lex pointed out that the critics should keep quiet: their loud demands will only entrench the Chinese position. Then the Economist argued the effect of an appreciation on trade imbalances would be far smaller than is being assumed. Perhaps, they say, it is not worth the diplomatic price.
And now a research note challenges the assumption that a currency appreciation would help combat inflation. As you can see from the chart, domestic inflation is highly correlated to the money supply six months prior. “A marked increase in inflation” is expected in the second half of this year, says Lombard Odier.
But a yuan appreciation would not work quickly enough to tackle this impending inflation, says the research team.
Some research at the BIS (Bank for International Settlements) in March 2007 looked at the pass-through from exchange rate changes to consumer prices: it found that a 1% change in the exchange rate changes consumer prices by 0.08% after 4 quarters and a cumulative 0.77% after 8 quarters in China.
So, to sum up: while inflation will rocket six months after high money supply, it would take nearly two years for the exchange rate to tame inflation again.
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