The debate on RMB exchange rate system has been going on for many years, and there are two tit-for-tat views and analyses on the whole. Professor Mundell, who won the Nobel Prize for his research on international finance, and Professor McKinnon, who specializes in Japanese and China exchange rate systems at Stanford University, believe that the best RMB exchange rate system at this stage is pegged to the US dollar. Almost all other economists with international influence, including the International Monetary Fund, investment banks and international academic circles, believe that the RMB should float.
In fact, the fixed exchange rate and the floating exchange rate are just two different exchange rate systems, and there is no right or wrong, but the behavior and adjustment methods of individuals, enterprises and macroeconomics are different under the two systems. At a certain stage, relative to a certain economic structure, fixed exchange rate may be more suitable than floating exchange rate. But at another stage, under another economic structure, floating exchange rate may be more appropriate. Therefore, when comparing the advantages and disadvantages of fixed exchange rate system and floating exchange rate system, we need to have a thorough understanding of the nature of the two exchange rate systems and the development stage and structure of China's economy.
The biggest advantage of the fixed exchange rate system is that the government helps individuals and enterprises to eliminate exchange rate risks and reduce the transaction costs of international trade and investment. After World War II, the international monetary system designed by economists such as Keynes, including the International Monetary Fund, which supervised the implementation of this system, was a fixed exchange rate system. The euro system advocated by Mundell is also a fixed exchange rate system among EU countries. During the period of 1994-2005, the Hong Kong dollar was linked to the US dollar, and the RMB was linked to the US dollar, which also belonged to the fixed exchange rate system. Obviously, the fixed exchange rate system has played an important role in promoting international trade and investment. The rapid development of China's foreign trade and foreign direct investment mainly occurred after 1994 RMB was pegged to the US dollar.
For countries in transition from a planned economy to a market economy, a fixed exchange rate also has a special function-helping to establish a relative price system that is more in line with market rules. In the planned economy, wages and the relative prices of food, housing, transportation, education and medical care can not really reflect the costs and benefits of goods and services. At the beginning of the reform, more than half of the income of urban residents in China was spent on food, while housing and medical care cost almost nothing. This relative price system is very different from the price system of various commodities and services in mature market economy countries, and obviously needs to be adjusted. The fixed exchange rate makes the relative price adjustment of all walks of life in China easier and more stable.
Another advantage of the fixed exchange rate is to restrain the domestic monetary policy, so that the interest rate and inflation of the local currency will not be too different from the major international currencies for no reason. For an open economy like Hong Kong, which is dominated by international trade and capital market, a fixed exchange rate is conducive to creating a relatively stable and predictable macroeconomic environment. For a developing country like China, a fixed exchange rate is also conducive to stabilizing inflation expectations and macroeconomic environment when the central bank's ability to formulate and implement monetary policies is not mature. After the RMB was pegged to the US dollar at 1994, China's inflation expectation was quickly controlled, and even there was a slight deflation during the Asian financial turmoil.
However, the restriction of fixed exchange rate on monetary policy may also become a problem. When the costs and prices of housing, medical care, education, services and other industries in China are rising too fast due to the rapid growth of manufacturing labor productivity, the central bank cannot alleviate the inflationary pressure through RMB appreciation under the fixed exchange rate system. Therefore, the fixed exchange rate system is basically applicable to China until the rapid growth of labor productivity in China leads to a serious rise in the price of non-tradable goods. Once the sustained productivity growth leads to obvious inflation, especially the price of non-tradable goods (such as housing), it is necessary for RMB to appreciate under the floating exchange rate, and it is more acceptable to the society. Especially in the environment of inflation, RMB appreciation will not lead to the risk of deflation.
The premise of successful implementation of fixed exchange rate is that the government has the ability to maintain a fixed exchange rate. This is not a problem for economies with large foreign exchange reserves and trade surpluses, such as Japan, China and Hong Kong Special Administrative Region, but it is a very difficult condition for some countries with perennial trade deficits in Latin America and Asia. Argentina, South Korea, Thailand, Indonesia and other countries were unable to maintain their official exchange rates during the financial crisis, because their persistent trade deficit led to the loss of foreign exchange reserves, and they had to let their exchange rates float.
The main advantage of floating exchange rate is that it provides an independent monetary policy tool for the central bank to control inflation, but the price is that individuals, enterprises and banks must bear exchange rate risks, including the speculative risk of RMB appreciation in the market.
Professor McKinnon of Stanford University has conducted the most thorough research on the risks of floating exchange rates in Japan and China. He put forward the theory of moral contradiction and conflict. Japan and China have maintained a huge trade surplus for many years, that is, accumulated net assets denominated in dollars, which was originally a virtue of thrift. However, after the expected appreciation of Japanese yen and RMB is formed and realized, local residents will generally be unwilling to hold devalued US dollars and prefer to hold appreciating local currency, which has formed an insoluble contradiction and conflict: local residents have accumulated net US dollar assets through trade surplus but are unwilling to hold US dollar assets! As a result, the official foreign exchange reserves rose sharply, which led to a large increase in local currency circulation, a decrease in local currency interest rates, and even a zero interest rate era, the so-called "currency liquidity trap."
A basic economic principle of McKinnon's moral contradiction and conflict theory is that under the market environment, the return on investing in assets in different currencies should be the same after adjusting the risk. For example, for the same risk, the return on investing in RMB assets is mainly reflected in the RMB nominal interest rate (= RMB real interest rate+China inflation rate), while the return on investing in US dollar assets is reflected in the US dollar nominal interest rate (= US real interest rate+US inflation rate). However, when RMB appreciates against USD, the return on investment of RMB assets also includes the appreciation rate of RMB, so: RMB nominal interest rate+RMB appreciation rate = USD nominal interest rate.
If the nominal interest rate of the US dollar is 6% and the annual appreciation rate of the RMB reaches 6%, the nominal interest rate of the RMB may be pushed to zero under the condition of open capital flow in China. This is also the reason why Professor McKinnon does not want the RMB to adopt a floating exchange rate system.
When there is no inflation (such as1Japan in the 1990s), McKinnon's analysis is completely correct. But once inflation occurs, the nominal exchange rate of RMB (RMB real interest rate+China inflation rate) can be much higher than zero. Once inflation occurs, due to the substitution relationship between inflation and appreciation, the pressure and speed of RMB appreciation will be reduced accordingly, and the risk of falling into the "currency liquidity trap" when the nominal interest rate of RMB drops to zero will also be reduced. It can be seen that maintaining an appropriate inflation rate caused by rapid productivity growth can reduce the zero interest rate risk caused by RMB appreciation and reduce the pressure of appreciation.
Therefore, I think the future inflation rate in China should be at least higher than the current inflation rate in the United States (about 2%-3%) but lower than the average inflation rate in Japan 1950- 1970 (about 5%-6%). The impact of low inflation on working-class and retired workers can be solved by linking wages/pensions with inflation index.