The basic idea I want to say through this post is that if China's economic growth has decoupled from that of America's, then it also need to decouple its monetary policy if it wants to stop the Chinese economy bursting like any previous economic bubble.
What has happened over the years that in order to support its exports the Chinese government has kept the yuan stable against the dollar or one could say that it has tied its monetary policy to US. So far it has mattered a little. But due to the current domestic deflation has lead to Chinese real interest rates to be among the highest of any big economy. But this monetary coupling will become increasingly dangerous.
America’s weak economy means its monetary conditions are likely to stay ultra-loose for far longer than it makes sense for China. Left in place too long, the currency alignment could swell an asset bubble.
Thus to re balance Yuan becomes a strong necessity if China wants to avert an asset bubble. This transition as Economist says "Will not be easy. The spectre of a stronger yuan will, temporarily at least, worsen China’s asset-price bubbliness, as foreign capital floods into the country in anticipation of a stronger currency" But still this calls for acting quickly and carefully rather than doing nothing.
The longer China continues to keep the Yuan at the current level, the bigger the distortions and the risks from any currency adjustment. Without an independent monetary policy China will eventually become a bubble economy. To avoid that fate, Beijing must let go of the yuan, so that it can raise interest rates to wipe out some of the access liquidity.
Happy Diwali...!!!
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