The Renminbi toward the free fluctuation of the exchange rate.

Abstract

According to the International Monetary Fund (IMF) , in 2017 China had the largest economy in the world by gross domestic product based on purchasing power parity, abbreviated GDP (PPP), but its currency, the Renminbi (RMB), also called Yuan, is still not completely liberalised and cannot float freely according to market-based forces. How is that possible? Is this a sustainable situation for China and for the rest of the world? If not, what are the next steps for China’s exchange rate policies? And how about the implication for Western Companies working with the Chinese market? In this thesis, I will try to answer these questions. Starting from a more theoretical point of view, two of the most famous fixed exchange rate systems operating since the end of the Second World War will be analysed: the Bretton Woods System (also called “Gold Dollar Standard”) and the European Monetary System (EMS). The problems with a fixed exchange rate system will be explained and will be understood why those systems have collapsed. China’s exchange rate situation will then be analysed, from its first PEG to the US dollar, underlying all the most important events during its journey through a more flexible exchange rate, to its today situation and the latest developments. Then the problem of the unsustainability of a fixed exchange rate in China will be looked at deeper, due to its current economic situation of first economy and first exporter of the world. In a free market, there is a supply-demand equilibrium that must be respected; a country can escape this equilibrium only if it is so small that it does not affect the global balance. This is not China’s case. China tried to escape this equilibrium with the stabilization of its currency to the dollar, and abandoning that PEG was an inevitable choice. With the help of the study of Hassan, Mertens and Zhang will be understand why. This study also brings to light a novel perspective about Chinese interventions in foreign market. Are those interventions a tactical move to maintain China competitiveness? Are they politically motivated? Or are they just a result of the stabilization policies? This will inevitably led to another problem; is the Chinese exchange rate undervalued? Many studies suggest that it is. As Stephen B. Kaplan suggests, an undervalued Yuan helped China pursue an export-led model of development, boosting economic growth and job creation. However, it also led to an overexpansion of the market and many financial difficulties had emerged. In this context, one question arises: why have the Chinese authorities not pursued a larger revaluation? An undervalued Renminbi is also a dangerous element for a further Capital Account Liberalization, a long-term primary goal for Chinese economy. Thanks to Lardy and Douglass’ study , it can be seen that a flexible exchange rate is a fundamental prerequisite for Capital Account Liberalization; opening Capital Account when the Yuan is substantially undervalued will accelerate capital inflows with speculative aim that can be destabilizing. As evidence for this thesis, we will analyse the Mundell Fleming Trilemma. It is clear that a free-floating exchange rate is an inevitable choice for China. When this will happen, which are the consequences for Western Companies working with China? Those firms must be prepared to face the evolutions of Chinese exchange rate and design the right strategies to get along with this process.