'At the beginning of 2005 one of the main issues in the world economy
is the question of exchange rates. The dollar has been falling quite
sharply in world markets for a number of reasons, one of which is the
large deficit in the current account of the US balance of payments.
The USA has been putting considerable pressure on China to revalue its
currency, which is currently fixed against the dollar, because of the
large trade surplus which China is running with the USA. The downward
fall of the dollar has led to upward pressure on both the euro and the
Japanese yen, to which the European Central Bank and the Bank of Japan
have responded differently. The Bank of Japan has sold yen in the
foreign exchange market, in order to keep the value of the yen down,
while the European Central Bank has allowed the value of the euro to
rise'.

?	What exchange rate policy should China adopt?

?	The reasons for this policy and its effect on households and firms in China?

?	The arguments justifying the chosen policy?

?	The arguments with regard to the exchange rate policies which the
other countries (e.g. Japan, EU) should adopt?

1) What exchange rate policy should China adopt?
Whatever suits the Chinese

2) The reasons for this policy and its effect on households and firms in China?
My guess is that China is building up a wodge of dollars that it
intends to spend wisely in the future.  There is some evidence for
this in that recently a Chinese delegation went prancing round South
America making $2bn 'investments' in raw materials operations - they
even invested $2bn in Cuba.

The effect on households is not that significant, China is
industrializing extremely fast, yet it still has a vast pool of
'untapped' labour. Pay rates and domestic prices are probably not
closely related to the 'exchange rate'.
If Chinese firms put up their prices to the USA then they might see a
drop in demand from the USA. Most likely, they currently set their
export prices in $US, so a revaluation of the Remembi would mean that
they would see a reduction in the amount of Remembi that they get for
the US$ that they convert to pay wages.
In other words they would probably just see a decline in profit.

3) The arguments justifying the chosen policy?
China is selling 'cheap' Chinese labour to the rest of the world, in
return it is buying in raw materials and capital equipment - for which
it (probably) largely pays $US. From the Chinese point of view
increasing the 'price' of labour and locally sourced goods makes
little sense.

4)The arguments with regard to the exchange rate policies which the
other countries (e.g. Japan, EU) should adopt?
- Japan - well Japan has huge investments in other countries,
including China, and those will mostly be in the $US bloc. Having a
high Yen means that their domestically produced exports are more
expensive, and that profits remitted back to Japan and converted to
Yen are lower. However there is no reason why they need 'convert'
those profits - since they will simply be reinvested outside Japan
anyway.
Japan might be experiencing a decline in its export manufacturing
sector, but that could be something that would happen anyway as Japan
invests in other low wage economies.

- The EU and UK are the ones getting it in the neck, as their goods
become significantly more expensive in the USA and in the $US bloc
(!!!).
Both are nervous of devaluing primarily for 'political' reasons, they
do not want their currencies called 'weak'. There are certain
advantages as oil and raw materials tend to be priced in $US - so
necessary imports have become cheaper - as are goods from ... China.
It is however a problem for exporters.

In my opinion the 'low' dollar has been deliberately engineered by the
USA, and is targeted at making life hard for the EU. I suspect that
the luke warm EU support for the US in Iraq is one of the reasons, and
another is that the US sees the Euro as a form of competition, so a
few spoiling tactics are hard to resist. To a great extent the USA is
right, the EU might be a free trade area, but to the rest of the world
it is a trade protection bloc.

Some intersting points frde-ga, but you miss some important issues.

1. The Chinese banking system is not open enough or established
enough, although China has turned into a more market-economy, to adopt
a flexible exchange rate regime at present. However, China it seems
has much pressure to adopt a flexible exchange rate regime.

http://english.people.com.cn/english/200005/11/eng20000511_40590.html
http://www.imf.org/external/pubs/ft/issues13/
etc..

During the Asia crisis of the mid 90's, China managed to avoid the
worst effects by using its large foreign currency reserves, and the
Asia crisis is largely blamed on the inflexible exchange rates.

Why does a fixed exchange rate regime suit China? - partly because it
can maintain its trade surplus by making exports cheap. But, if i
recall, estimates are that its currency is undervalued by as much as
20%.

2. "Pay rates and domestic prices are probably not
closely related to the 'exchange rate'." Exchange rates in flexible
regime is determined by supply-demand. If demand for exports from
China goes up, then demand for its currency goes up and, all things
remaining the same, domestic prices will go up as well as wages. China
does have a huge surplus of labour though!

4. "Both are nervous of devaluing primarily for 'political' reasons" - EU and UK...

Both operate under a floating exchange rate regime, meaning that they
cannot 'devalue', the exchange rates 'appreciate' or 'depreciate'.

I should point out that under a floating exchange rate regime, a
government cannot simply change its exchange rate!!! It can use its
currency reserves to buy/sell and create demand/supply, or use
monetary policy, changing its interest rate and so make its currency
more/less attractive as investment. But these currency reserves are
not infinite. And this would not be a floating exchange rate - it
would be under 'managed flexibility'.

- also, for the USA to have engineered its weak currency is beyond the
controls of the government or some conspiricy!!

The USA has run huge trade deficits in the recent past, and now
everyone is dumping their dollars. The deficit has been about $500
billion a year. The USA has been buying foreign goods, leaving a
deficit of about 5% of its economy per year. The world wants Euros,
had enough of dollars! To put it into context - a trillion and a half
dollars or more every day are traded on the currency markets.

Sorry if this doesn't asnwer the question: fixed or flexible.

I'm not sure that the Chinese banking system is that unsophisticated
- or rather it does I think have some sophisticated bits
- long before 1997 the PRC had Hong Kong well under financial control
I can't remember the details unfortunately

My impression is that the PRC is simply not interested in playing the
'currency game' - I suspect they regard it as pure time wasting.

About Governments setting exchange rates, large players like the USA
do have a great deal of 'verbal influence' over the markets
- also the markets are very volatile and easily influenced
- I remember one FOREX trader telling me how he would like to 'take a
view' but in reality he had to 'chase the market'.

I am very unconvinced that the World wants Euros, sure they will pile
into the Euro if they think that it will rise, but if they see the $US
on they turn, they'll be out of Euros in a trice.

Also, very little of the currency traded on the markets each day is
actually used for any form of 'real trade'.

"Participants undersorced the importance of healthy, competitive and
efficient financial markets in assuring that their economies achieve
their full frowth potential. Chinese participants described steps
being undertaken to strengthen the banking system and to develop
domestic capital markets, including recent steps in capital market
reform. China reiterated its commitment to further liberalization and
opening of its financial services sector. The Chinese side reaffirmed
China's commitments to further advance reform and push ahead firmly
and steadily to a market-based flexible exchange rate and described
the steps the Chinese government has taken to create conditions to
establish a more flexible exchange rate." (Peoples Daily, 2004)

China's banking system is not developed enough to currently take on a
flexible exchange rate. It is however moving that way. Hong Kong is
not China.

I think the world will be wanting Yaun in 50 years! At the moment
thought, there are too many dollars floating around.

Verbal power perhaps, but ultimately it is policy that counts: Never
trust a polititian.