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China's Devaluation Has Nothing to Do with Free Market Forces

August 14, 2015 in Economics

By James A. Dorn

James A. Dorn

China’s decision to abruptly devalue its currency against the dollar is being sold as a move toward a more market-determined exchange rate, but it is sure to infuriate those in Congress who have long argued that China is a currency manipulator.

When Chinese President Xi Jinping visits Washington next month, he will face a more hostile Congress, even if the International Monetary Fund supports the new currency arrangement whereby market forces have a greater role in setting the daily central parity for the yuan-dollar exchange rate.

It is wishful thinking, however, to believe that China’s exchange rate regime will be left to the free market. The People’s Bank of China kowtows to China’s State Council, and the consensus is that maintaining “stability” trumps market liberalization. There is little doubt that stabilization measures (i.e., intervention) will limit movements in the exchange rate to what Beijing thinks will be desirable, not what market participants think.

The real issue in determining the pace of reform is the delicate balance between state and market in China’s “market socialist” system. True markets require institutions that protect and cultivate freedom. People have to be free to choose, which means they have to have effective rights to buy and sell, both domestically and internationally, and they have to have enforceable contracts, an independent judiciary, a transparent and just legal system and a free market in ideas. China is seriously lacking on all fronts.

To strengthen its currency, China needs widespread liberalization.”

In a competitive exchange-rate system, millions of traders — not a central authority — will take account of all relevant information and there will be constant, small adjustments in free-market rates. Futures markets will exist to smooth rates over time and hedge bets. One-way speculation will not occur, as it does under pegged but adjustable rates.

The surprise drop in the yuan-dollar exchange rate by 1.9 percent on the first day of the new scheme for setting the central parity is reminiscent of price “reform” in the Soviet Union under central planning. Prices would be frozen for long periods, without regard to world prices, and then suddenly increased. Without the guiding hand of markets, and without free trade, there was no way to know the right prices — that is, those that would clear the market.

China has allowed more flexibility in the yuan’s movement around the official parity since July 2005, but within strict …read more

Source: OP-EDS

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