It seems likely that China’s central bank will reduce its grip on the U.S. dollar.
An editorial on the People’s Bank of China website recently made the case that China should tie the RMB to a basket of currencies rather than to the U.S. dollar. As it stands, China’s currency is pegged to a basket of currencies, but the dollar has appeared to dominate the RMB’s exchange value. China’s foreign exchange system may calculate a RMB exchange rate index against a basket of currencies that gives less weight to the dollar in order to reinforce market forces.
Reducing the weight of the dollar in the exchange rate will reduce constant comparisons between the RMB and the dollar; given appreciation expectations of the dollar, corresponding appreciation expectations of the RMB have followed, and where they have not, investors have displayed fears of devaluation. Changing the dollar dependence will also remove pressure on Beijing to further strengthen the RMB as the dollar gains value after the U.S. Federal Reserve interest rate hike. This will permit China to maintain a more independent monetary policy.
China’s efforts to peg the RMB to a basket of currencies, with less emphasis on the dollar, have failed in the past, particularly in the face of the global financial crisis. A tighter peg to the U.S. dollar helped China’s economy to maintain monetary stability as real economic indicators slid. Now that the global crisis appears to be somewhat contained, the time may be ripe for China to remove its strict adherence to the dollar.
So will they or won’t they? It seems likely that China will reduce its grip on the dollar and it makes sense that it would do so in the short to medium run. This will certainly mark a change in China’s development trajectory, as its currency has closely tracked the dollar for two decades.