China's Exchange Rate Policy: A Double Edged Sword

Few policies have such far-reaching influence on an economy as exchange rate controls. Over the last decade, China has maintained an artificially devalued currency by purchasing U.S. dollars while selling domestic Renminbi RMB. In theory, this practice will benefit the economy by making exports cheaper. Cheap exports have been an important component of the PRC s investment-driven growth model, which transformed China into an economic powerhouse. Although a devalued currency makes exports cheaper, it also makes imports more expensive. As Chinas economy evolves, the PRC recognizes the need to shift to a more innovative consumption-driven growth model from the current investment-driven model. This study argues that a devalued RMB is inhibiting this progress because it undermines the consumptive power of its citizens through more expensive imports, financial repression, and capital controls, all of which are closely linked to a devalued RMB. This study will look at imbalances in Chinas consumption and production structures affected by a devalued RMB and identify the artificial winners and losers of the current policy. Also, gradual RMB appreciation over the last decade will be analyzed to determine the extent an increasing RMB has moved economic imbalances.