Foreign Exchange Controls

Published on Author Mike

China catches flak for intervening in exchange markets. You should however think about the challenges faced by developing countries with small financial markets. A nice piece on that is on the Economist’s View blog, looking at Cyprus as the point of departure.

Now that China is “large” in international markets the “hot money” argument is less compelling. However, domestic capital markets are still institutionally young, and so from that perspective maintaining capital controls is not such a bad idea. But doing that requires pegging the exchange rate – or to use the old jargon, setting up a “crawl” [a term used in Europe] since the US$/RMB rate shows a near-monotonic appreciation of the RMB. In our day we similarly “manipulated” our own currency.

Furthermore as noted in class, the real exchange rate has not been flat (see the graph at the top of this website’s home page). In addition, while policymakers assume “opening” the market would lead to a sharp appreciation of the RMB, Chinese portfolios are NOT diversified internationally, so there would be a real incentive to purchase dollar (and euro and yen and…) assets. However, non-residents have been able to buy yuan assets (albeit with restrictions). So a priori it possible that an institutional change of the sort various vocal senators and representatives want would lead to a depreciation of the RMB. That would produce even louder howls of manipulation even if it was in fact a market outcome.