One of the most important, and permanent, outcomes of the international financial crisis is that China has acquired a hard currency - indeed China's yuan has become one of the hardest currencies in the world. As this process is of considerable importance for both the world and Chinese economies the it is worth outlining in some detail.
The fundamental data is set out in Figure 1 - which shows the change in the exchange rates of four currencies against the dollar since the beginning of 2000. The four are the world's three most important non-dollar currencies (the euro, yen, and yuan) plus the rupee - the latter included not because it has the same weight in the world economy, as yet, as the three others but because India is, after China, the world's largest developing economy. The fundamental trends in currency shifts are clear.
The first feature is the long term policy of the Japanese government to seek to keep down the exchange rate of the yen against the dollar. By 21 November 2008 the yen had risen by only 6.6 per cent against the dollar over almost an eight year period. Furthermore this rise in the yen's exchange rate was entirely due to trends since the beginning of the international financial crisis.
For most of the last eight years the exchange rate of the yen against the dollar has actually been lower than its level at the beginning of 2000 - this period coinciding with relative almost complete stagnation in the Japanese economy. It remains to be seen whether this policy of Japan can be successfully continued during the present international financial crisis - which has seen the emergence of strong and repeated upward pressure on the yen's exchange rate.
In contrast to the yen the euro rose very strongly against the dollar after 2002. By April 2008 the euro was 60 per cent above its exchange rate against the dollar at the beginning of 2000. The exchange rate of the euro against the dollar has fallen significantly since the international financial crisis began but, nevertheless, on 21 November 2008 the euro was still 25 per cent above its dollar exchange rate at the beginning of 2000.
The movement of the yuan's exchange rate against the dollar is clear, simple, and evident. Following the ending of a fixed exchange rate in 2005 the yuan has appreciated against the dollar - rising by 21 per cent by the beginning of September 2008. The yuan's exchange rate since the beginning of the international financial crisis has stabilised and on 21 November it was still 21 per cent above its 2000 level.
This stability of the yuan against the dollar since the financial crisis began, however, disguises the upward movement of the yuan against most other currencies, apart for the yen, as the dollar has itself been rising sharply - therefore taking the exchange rate of the yuan against other currencies up with it. This trend is illustrated in Figure 2 which shows the broad trade weighted index of the dollar's exchange rate. The sharp recovery of the dollar since the beginning of the international financial crisis is evident and as the yuan has been stable against the dollar the yuan's exchange rate has risen against most other currencies. This trend is considered in more detail below.
Considering the rupee, its exchange rate against the dollar, after falling in 2000-2002, rose to reach 11 per cent above its beginning of 2000 level by October 2007. After that the exchange rate of the rupee against the dollar began to fall and it has declined sharply during the financial crisis. By 21 November the exchange rate of the rupee against the dollar was 12 per cent below its level at the beginning of 2000.
Taking these trends together the emergence of the yuan as a currency with 'hard' characteristics is evident. The yuan's exchange rate has substantially appreciated against the dollar, the yen and the rupee. For most of the period since 2000 the yuan did not rise in its exchange rate against the dollar by as much as the euro, but the euro has been subject to considerable fluctuations and it has since fallen sharply from its peak. By 21 November the yuan had risen by almost as much as the euro against the dollar and had done so in a stable way. The yuan was, therefore, both a currency with a rising exchange rate and one with a stably rising exchange rate - a virtually perfect definition of a hard currency.
Before going on to examine the implications of these trends Figure 3 shows the above exchange rate movements not in terms of the change in exchange rates against the dollar but in terms of their movement against the yuan.
The trend shown is clear. The only major currency over the last six years against which the yuan has had the advantage of a lower exchange rate has been against the euro - a trend aiding Europe overtaking the US as China's largest export market. That advantage is, however, rapidly disappearing and the yuan has returned during the financial crisis to approximately its beginning of 2000 exchange rate against the euro. Against the dollar, the yen, and the rupee the yuan has been persistently been a currency with a higher exchange rate. By 21 November, compared to the beginning of 2000, the exchange rate of the yuan had risen by 14 per cent against the yen, 21 per cent against the dollar, and 38 per cent against the rupee.
There are,naturally, many implications of the emergence of China as a country with a hard exchange rate. Some of these will be looked at in the future on Key Trends in Globalisation. However for the present two key ones should be drawn attention to.
First, the issue will be posed for China of whether it will allow the yuan to become, to some extent, a reserve currency. The yuan is both stable and any potential for exchange rate movement is likely to be on the upside. A central banker, or private individual, is capable of reading such trends and wishing to hold part of their reserves in the form of yuan.
Second, a consistent and significant upward pressure on the exchange rate will lead to significant internal reorganisation of the Chinese economy. China must learn to compete at a higher exchange rate. As Key Trends in Globalisation noted previously this has major implications for China - not only in general but in terms of the form of economic stimulus package required to deal with the current international financial crisis: 'This [higher exchange rate] requires that... [China's] whole economic mechanism become more efficient, which can only be achieved through investment. China will cease to compete as a pure low wage economy – Vietnam and other economies now occupy the place China did twenty years ago. High levels of investment are therefore vital if China's economy is to compete in this new context.
'Put in other terms, China's traditional strategy has been to keep its currency's exchange rate down to the level of productivity of its economy. In the future China will have to raise the level of productivity of its economy up to its appreciating exchange rate - requiring gigantic further investment in its productive base.
This makes it vital that China's current economic stimulus package does not aim strategically at reducing the level of saving and investment in the economy in favour of consumption but aims to maintain China's very high savings and investment levels. This does not exclude, of course, than in attempts to maintain short term demand in the economy consumpton cannot be boosted. But the key strategic goal must be the maintain the very high levels of savings and investment that have been the key to China;s economic success and which will be even more vital now that it is acquiring a 'hard' currency.
As Key Trends in Globalisation noted: ''the cyclical requirements of economic management, that is ‘Keynesian’ anti-recessionary measures, coincide with the structural requirements of a high investment level. So far the Chinese government is heading in the right direction in announcing successive waves of infrastructure and other investment – railways, roads, housing. The fact that China has a large state owned economic sector allows it to take far more direct ‘Keynesian’ measure to sustain investment than are available in the US or Europe.'
But China's entire future economic strategy, and that of the rest of the world, must now take into account that China has acquired a hard, and hardening. currency. It is a historic, and in its implications, major shift for both China and the world economy.