Should China continue to peg the yuan?

One estimate is that China has been spending about $400 billion to prop up stock and currency prices, but with no success.  Might market-determined, flexible prices have some value today?

Cheng-chung Lai and Joshua Jr-Shiang Gau reiterate a well-known point about the 1930s:

It is often argued that the silver standard insulated the Chinese economy from the Great Depression that prevailed in the gold standard countries during the period 1929–1935. Using econometric testing and counterfactual simulations, this article shows that if China had been on the gold standard (or on the gold-exchange standard), the balance of trade of this semiclosed economy would have been ameliorated, but the general price level would have declined significantly. Due to limited statistics, two important variables (GDP and industrial production) are not included in the analysis, but the general argument that the silver standard was a lifeboat to the Chinese economy remains defensible.

China during the Great Depression remains very much an underexplored research topic.  Here is Loren Brandt and Thomas Sargent on China later going off the silver standard.  Here is Milton Friedman on the same (jstor).  The Chinese were not able to sustain that peg either.  So what should the smart money bet on today?

Here is Lars Christensen on the falling apart of the dollar bloc.


Indeed, hard money currencies can work. There was a de facto "Taylor Rule" for gold (sterilization) and as TC says for silver there was a managed currency in pre-communist China. Not that it matters much, since mostly money is neutral, but that's an aside.

Watch the reserves.

China's oligarchs will demand intervention until intervention is no longer possible. The current situation is not a stable equilibrium.

Renminbi literally means "people's currency." We may find out what the people think of a hyperinflating yuan. Will XI Jinping have to send in the tanks?

Great post by Lars. Pegs are inherently unstable, you might as well just dollarize if you really want to hedge the dollar.

It will be very interesting if they ever let the Yuan really float and be fully convertible. Will the flood of money going in even put a dent in the pent up demand to get money out? Would the flood out be a one time event? The money going out wouldn't have anywhere to go but the US right?

Lars is right. Break the quasi-dollar peg. US+China =/= logical currency area.

Non-FDI CNY outflow chart

The answer to the headline question is an obvious no, but how to get from tradition to modernity in the middle of a confidence crisis is a lot less obvious.

I put together a few charts that I think help frame two major aspects of the problem: 1) M2 (and loans & deposits) are too big and growing too fast, which helps explain the vulnerability to this kind of rushing out of yuan deposits. 2) NGDP growth especially in $ terms is decelerating very rapidly as export industries hit an overcapacity wall, undermined commodity prices and thus undermined China's former fastest-growing export markets.

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