China’s Currency Manipulation
Mundellian trilemma is a key concept to understand China’s initiatives taken to control its currency. Also known as the impossible trinity, Mundellian Trilemma is a theory proposed by Canadian economist Robert Mundell which states that it is impossible for any country to have all three of the following at the same time: a fixed foreign exchange rate, free capital movement and monetary sovereignty.
Professor Michael W. Klein from Tuft University was discussing insights into international macroeconomics, and he quoted, “Government faces the policy trilemma, the rest is commentary.” Indeed, in China’s attempt for a fixed exchange rate, all the effort it has made has been between the sacrifice of its monetary sovereignty and its free cash flow. Accordingly to the Mundellian Trilemma, all of China’s principal measures employed can be characterized into two groups: the sacrifice of its monetary sovereignty and control of cash flow.
In terms of cash flow, China has long adopted strict capital controls, as well as its market interventions. With the current massive outflow of capital, China’s capital control has tightened and has effectively stopped many real estate investors from investing overseas. Aside from its capital control policy, China’s market intervention is also a very powerful method which China employs in order to absorb the large inflow of foreign capital — a result from its trading advantage. The People’s Bank of China intervenes with the market through printing RMB and exchange the for foreign currency from exporters. Since the bank has the power to print as much RMB as it deems necessary, they ensure that Chinese exports remain cheaper and that the Forex rate remains in a desired range. However, to avoid the risk of hyperinflation, PBOC then sell certain amounts of domestic currency bonds which will away the excess cash from open markets.
In terms of the sacrifice that China has made over its monetary sovereignty, it is mainly shown in its interest rate fluctuation, as well as reserve ratio changes and discount ratio changes. From there they can alternate the liquidity in the market, therefore controlling inflation, and in turn, the exchange rate.
In conclusion, although China has essentially transitioned into a market economy through time, it still holds many characteristics of a command economy, particularly in its currency policy — tightly controlled by the central government. The Communist Party of China has long been intervening with China’s currency, the Renminbi, and has developed an established strategy to keep a firm grip on its financial world, aiming for the internationalization of the RMB. So far the strategy seem to work well for this mixed socialist and free-market economy in regards to economic growth and trends.
