The Yuan Dilemma

China, the world’s third largest economy, is leading the world in emerging from the recession caused by the credit crisis. Its economy grew at a rate of 8.9 % in the third quarter of this year. Next year, it is expected to surpass Japan to become the second largest economy in the world. It has chalked up a foreign reserve of nearly US$ 2 trillion. Such is its strength of growth.

Its economic expansion is based on the mode of too much investment, too high saving and too little consumption. Its utmost priority domestically is job creation and social stability. It already has surplus manufacturing capacity. So, the only way to increase employment is to sell more. They do this by deliberately holding down the value of the Yuan. This action is generating a lot of disgruntlement from the rest of the world, in particular the USA. They are all suffering from a trade deficit with China.

The other way for them to increase production is to step up domestic consumption. This method is more desirable to the westerners as it would not add to their trade deficit with China.

But the holding down of the Yuan has its adverse consequences too. The government has to sell Yuan to keep its exchange rate low. This has resulted in a 29 % increase in the money supply in the last six months. Also, expectation of the revaluation of the Yuan has attracted a US$150 billion inflow of speculative funds in the same period. All this extra liquidity is causing asset price inflation. Apartment prices are reaching record levels and the stock market has risen 74 % this year.