There Is No "Serious Underestimation" Of The RMB Exchange Rate.

Recently, with the release of the latest US trade data, the RMB exchange rate has become the target of some economists and politicians in the United States. According to the statistics released by the US Department of Commerce in June 10th, the US trade deficit with China in April has increased from 16 billion 900 million US dollars in March to US $19 billion 130 million in April. Meanwhile, the trade deficit between the United States and other trading partners (except Canada) is decreasing.

Accordingly, some economists worry that this international trade imbalance as one of the "main culprits" of the recent financial crisis will further intensify.

US Treasury Secretary Geithner said later that the US side will put pressure on China to find a fundamental solution.

US Senator Schumer even claimed that in the next few weeks he would work with his colleagues to move forward a legislation to allow the US Department of Commerce to implement anti-dumping and countervailing duty laws against China and other "fundamentally inaccurate" countries.

As a result, the issue of RMB exchange rate has once again been brought to the forefront of Sino US trade disputes.

So how do we see the current level of RMB exchange rate?

What is the relationship between the RMB exchange rate and China's balance of payments?

Will RMB appreciation reduce China's balance of payments surplus?

All of these require us to think deeply.

One important reason why some western economists and politicians keep talking about the RMB exchange rate is that "the RMB exchange rate is seriously underestimated". Therefore, we have to clarify this issue first.

Economists have always had different views on the determination and measurement of the reasonable exchange rate of currencies in both countries.

Among them, the most influential and often used by some economists in the West as a theoretical basis for attacking the RMB exchange rate is purchasing power parity.

According to this theory, the internal value of a country's currency determines its external value, in other words, the domestic price level determines the foreign exchange rate of its own currency.

In view of this, whether the RMB exchange rate is undervalued can not be divorced from the domestic price level.

Since the RMB exchange rate was merged and managed floating exchange rate in 1994, if we look at the price changes in China in the past 16 years, we can see that except for 1998, 1999, 2002, 2009 four years CPI presents a slight negative growth, the other 12 years CPI is positive, of which 1994 and 1995 CPI increase is as high as 24.1% and 17.1% respectively; the growth rate of CPI in the year of 17.1% is as high as that.

Although prices in the US are also rising in the same period, the growth of CPI in the US is much lower than that in China due to the large quantities of cheap consumer goods imported from China and other developing countries.

Therefore, according to the theory of purchasing power parity, the exchange rate of RMB against the US dollar should not only be appreciated, but should be depreciated.

But in fact, from the exchange rate of 1 US dollars to 8.7 yuan in 1994 and the current 1 US dollar to 6.82 yuan, the renminbi has appreciated by nearly 28%.

Obviously, even according to the theory of purchasing power parity, the current RMB exchange rate does not exist in the so-called underestimation issue, but it is overrated.

Some economists and politicians in the West have repeatedly forced the appreciation of the renminbi, which also stems from China's sustained balance of payments surplus.

They believe that because of the underestimation of the RMB exchange rate, China's trade competitive advantage has resulted in the expansion of China's balance of payments surplus.

It is true that after entering twenty-first Century, China's current account, capital and financial items of the balance of payments account for a continuous double surplus phenomenon, and the surplus has increased continuously, from 52 billion 100 million US dollars in 2001 to US $445 billion 100 million in 2008, while the double surplus in 2009 has shrunk, but still up to US $393 billion 200 million.

However, the question is whether there is a causal relationship between China's double balance of payments and the undervaluation of the RMB exchange rate.

The answer is No.

On the one hand, as mentioned above, there is no so-called underestimation of the RMB exchange rate. The underestimation of the RMB exchange rate as the root cause of China's balance of payments surplus is far fetched. On the other hand, facts have long proved that China's balance of payments surplus is not necessarily related to the RMB exchange rate, and the appreciation of the RMB exchange rate can not solve the problem of China's balance of payments surplus.

For example, since the reform of the RMB exchange rate regime in July 2005, the RMB exchange rate has appreciated by more than 21%, but China's balance of payments surplus has not decreased. Instead, it has increased rapidly, from 223 billion 800 million US dollars in 2005 to 445 billion 300 million US dollars in 2007, 445 billion 100 million US dollars in 2008 and 393 billion 200 million US dollars in 2009.

Obviously, China's balance of payments surplus is not necessarily related to the RMB exchange rate, but for other reasons.

Trying to force the appreciation of the renminbi to solve the problem of China's international balance of payments surplus is like seeking help from others.

Practice over the past few years also shows that the appreciation of the renminbi will not only solve the problem of China's balance of payments surplus, but may be the reason for the expansion of the balance of payments in China.

Because, under the background of the slow appreciation of RMB, speculative capital has gained the risk free arbitrage opportunity. Driven by interests, it will inevitably stimulate a large number of speculative capital to enter China through trade and non trade channels. This leads to the fact that China's balance of payments surplus is not only difficult to reduce, but also further expanded; and the expansion of the balance of payments surplus further increases the pressure of RMB appreciation and the expected appreciation of RMB by international speculative capital, which will further inflow into China through various channels and expand China's balance of payments surplus.

Thus, a vicious circle of RMB Appreciation - China's balance of payments surplus - the continued appreciation of the renminbi - the further expansion of the balance of payments surplus is formed.

Obviously, the solution to this cycle must not be the endless appreciation of the RMB, but the basic stability of the RMB exchange rate.