A Case Study of the Controversies of the Chinese Currency Regime

The debate on whether or not the Chinese currency is undervalued has been one of the most intensely debated economic subjects in recent times. The opinions amongst economists as well as politicians are all but homogenous. Through several different calculations, it has been estimated that the Chinese currency is undervalued, and should be appreciated, by as much as 30%. On the other hand there are several economists who think that this would cause severe damage to the Chinese economy with a clear risk of throwing it into a recession. Those who believe the latter either argue for no change from the present exchange rate policy until significant actions have been taken to sanitise the financial markets, or else that small liberalisations of the restrictions on capital flows are needed first. We make our own extensive examination of current theories and how they apply to the specific Chinese data. For instance data on China’s trade balance and the open market actions of the People’s Bank of China to maintain the exchange rate to the dollar while at the same time trying to keep its inflation goal. We also take a deep look at the Chinese domestic markets, the financial system, the possible effects on investment levels of abandoning capital restrictions etc. Eventually, we come to the conclusion that small gradual liberalisations of the restrictions on capital flows at the same time as the country takes serious measures to deal with its weak financial system is the best medicine for China