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

35 Pages Posted: 15 May 2014

See all articles by Ronald McKinnon

Ronald McKinnon

Stanford University, School of Humanities & Sciences, Department of Economics (Deceased); CESifo (Center for Economic Studies and Ifo Institute for Economic Research) (Deceased)

Gunther Schnabl

University of Leipzig - Institute for Economic Policy

Date Written: July/August 2014

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.

Keywords: China, exchange rate stabilization, financial repression, inflation, dollar standard, internationalization of RMB

JEL Classification: F3, F4, F5

Suggested Citation

McKinnon, Ronald and Schnabl, Gunther, China's Exchange Rate and Financial Repression: The Conflicted Emergence of the RMB as an International Currency (July/August 2014). China & World Economy, Vol. 22, Issue 3, pp. 1-35, 2014, Available at SSRN: https://ssrn.com/abstract=2437163 or http://dx.doi.org/10.1111/j.1749-124X.2014.12066.x

Ronald McKinnon (Contact Author)

Stanford University, School of Humanities & Sciences, Department of Economics (Deceased)

CESifo (Center for Economic Studies and Ifo Institute for Economic Research) (Deceased)

Gunther Schnabl

University of Leipzig - Institute for Economic Policy ( email )

Institute for Economic Policy
Grimmaische Straße 12
Leipzig, 04109
Germany

HOME PAGE: http://www.wifa.uni-leipzig.de/iwp/

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