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Sunday, July 20, 2003

Undervalued Yuan 

When I feel like I have nothing better to do - a feeling that I encounter frequently - I check out the Big Mac index of The Economist. After all, who can deny it's great fun to find out which currencies are the most undervalued/overvalued in the world? Over time, I have come to notice that Asian currencies have been the most consistently undervalued currencies in the world, barring the few exceptions like the South African Rand or the Aussie dollar. Of the Asian currencies, the Yuan tends to be the most undervalued currency of all. Both the Economist and Businessweek address the issue and its implications in recent issues.

Jeffrey Garten writes in Businessweek -- An even bigger problem is China, where large trade surpluses and growing reserves should dictate a revaluation of the yuan. Nevertheless, the currency remains fixed to the dollar at a rate of 8.2 to 1. Every time the dollar notches down, the Chinese currency automatically follows suit, making that country's exports even more competitive. As long as the tight dollar-yuan linkage exists, other Asian nations won't allow their currencies to float upward. They refuse to put themselves at a competitive disadvantage.

The Economist concurs -- In a free market, China's currency would surely rise. But demands from foreigners are likely to fall on deaf ears. The Chinese government is worried about rising unemployment as jobs are lost in unprofitable state companies, and deflation remains an issue. Moreover, until banks are reformed and non-performing loans tackled, it would be dangerous to liberalise the capital account. It would be safer to repeg the yuan at a higher rate. But most economists reckon that, at best, the yuan's band will be widened slightly over the next year, without allowing room for any significant appreciation. And, so long as the yuan is pegged to the dollar, other Asian countries will have a big reason to resist appreciation too.