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China's choice of exchange rate regime: What is in the interest of the euro zone?

- "China has a choice between several exchange rate regimes for the renminbi:
• pegged to the dollar, as before the summer of 2005 and between the summer of 2008 and the spring of 2010;
• with managed appreciation against the dollar alone, as between the summer of 2005 and the summer of 2008;
• pegged to a currency basket (dollar, euro, possibly also the yen), as has probably been the case since May 2010;
• with managed appreciation against a currency basket;
• much later, given the under-development of China's financial markets and the need to remove currency controls, flexibility."
- "We seek to determine which system is most in the interest of the euro zone:
• a fixed RMB/USD exchange rate leads the People’s Bank of China to buy dollars to prevent an appreciation of the renminbi, which pushes up the dollar against the euro and is favourable to the euro zone;
• a managed appreciation of the renminbi against the dollar is disastrous for the euro zone, because it causes China to stop buying dollars, thus resulting in an appreciation of the euro against the dollar;
• a fixed exchange rate between the renminbi and a currency basket normally results in China buying the currencies in the basket to prevent the renminbi from appreciating against the basket. If the basket is weak relative to the renminbi, there is buying of dollars and euros, which does not prevent a depreciation of the dollar against the euro, unlike in the case of the peg against the dollar alone;
• if the renminbi appreciates against a basket, China will stop buying dollars and euros, which does not cause a fall in the dollar against the euro, unlike in the case of a gradual appreciation against the dollar."
- "From a perspective of gradual appreciation of the renminbi against the currencies of OECD countries, it is therefore in the interest of the euro zone to ask that China take a currency basket as reference."
- "Moreover, in the near term, if this basket includes other currencies (yen), the fact that China starts to buy the other currencies will drive down the euro against those currencies."
- "The question of the renminbi becoming a trade currency (which the Chinese government is trying to promote in Asia) may also arise. If the renminbi is substituted for the dollar, the demand for dollars will decrease, which is bad for the euro zone."

Natixis Flash Economics 381 20100727

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