: China has progressed phenomenally with its per capita income climbing to $6000 on a purchase power parity basis. The top ten functionaries of the Communist Party of China are all qualified engineers. Even the previous president of China was an engineer. China does not have a multi-party democracy. But elections for CPI positions start at every village. The candidates win elections generally due to their ability and ideas to solve problems facing people. Very little election propaganda is tolerated or practiced. China has become the manufacturing hub of the world. Most Western and Japanese brands are manufactured in China. China has been growing at a rate of 9% economically. It is attracting more than $60 billion in foreign direct investments annually. It has also built a very large foreign exchange reserve of nearly $800 billion.
The developed nations are particularly worried about a rising China. They believe that the Chinese currency, yuan, is held artificially low by the Chinese authorities. China has increased the value of yuan by 2% to 8.11 yuans per dollar in July 2005. It has also pegged yuan to a basket of currencies including dollar, yen and euro.
This is based on a paper presented by Professor Sankarshan Acharya of University of Illinois on August 14, 2003 at the Hong Kong Monetary Authority about “exchange rate dynamics for developing economies.” The author was also slated to present this paper at the People’s Bank of China but could not visit Beijing due to SARS.The paper presented at HKMA has the following arguments.
1. China has realized immense benefits by fixing a low yuan-dollar exchange rate:
1.1 China has neutralized the game of currency manipulation by calibrating yuan to dollar, which is in the domain of the U.S. Federal Reserve.
1.2 China has become a manufacturing hub to create millions of jobs.
2. But costs of fixing a low yuan-dollar exchange rate by decree are also serious:
2.1 Potentially brewing social instability due to widening wealth disparity between a few foreign exchange earners (exporters and expatriates) and the rest.
2.2 Possibly a latent explosion of non-performing bank loans. Low yuan value results in the creation of more fiat money than necessary in a few private accounts of exporters and expatriates. Excessive money held in bank deposits leads to suboptimal lending, which results in non-performing bank loans.
2.3 Only the Chinese authority can research if social discontentment is brewing and if non-performing bank loans are exploding, since data are not available to public.
2.4 Based on the above research, only the Chinese authority should determine the yuan value by trading off their job growth against banking and social instability.
2.5 Yuan is, de facto, trading at a higher value than the official 8.27 yuan per dollar because of the possibility of default in bank deposits of exchange earners. This poses a potential danger of bank run and panics, decimating the confidence of international investors in yuan and Chinese economy.
2.6 Bank runs and panics would erase any hope of making yuan a reserve currency of the world. Making yuan a reserve global currency is an optimal Chinese strategy to undo currency manipulation.
3. Within a few weeks of my talk, the Chiefs of Hong Kong Monetary Authority and the People’s Bank of China met to grant more authority to a newly established bank regulatory authority to monitor non-performing bank loans. Then in a few months China has infused $70 billion to recapitalize bank equity. A year after the talk, many Chinese in Shanghai have been reported to be withdrawing vast sums from their banks in sacks for lending to borrowers directly. The gap in weath of the very rich and the rest of the Chinese society is widening ominously. This is showing social tensions.
Unless China succeeds in establishing democracy to attract Taiwan and Hong Kong, its latent problems can erupt.It is possible that China will adopt democracy in some form. In the mean time, though, China will grow economically and militarily.