Fed Rate Cuts Force China To Accelerate Yuan Appreciation
As Yu Yongding,former adviser to the People's Bank of China, notes, the widening interest rate gap between China and the U.S. could increase the inflow of "hot money" into China. That in turn will fuel higher money supply growth unless the exchange rate appreciates. That in turn implies that interest rate increases could prove useless in cooling down the economy.
Instead, other measures must be used, including higher reserve requirements and a higher value of the yuan versus the dollar. However, if the U.S. recession reduces exports enough, China may not need to tighten monetary policy much further, so higher reserve requirements doesn't seem necessary, appropriate or likely. A higher yuan is appropriate for other reasons and should therefore be the only measure undertaken at this point. Together, the higher yuan and the U.S. recession should reduce the current account surplus and accumulation of foreign exchange reserves enough to reduce money supply growth and price inflation to levels deemed more appropriate by the Chinese leaders.