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Stefan Karlsson

Yuan appreciates more than 3 percent in real terms

The yuan is growing against the dollar. What does this mean for US-China international competitiveness?

By Guest blogger / September 13, 2010

Job-seekers visit booths of companies at a job fair in Wuxi, Jiangsu province, in January, 2008. China's unemployment is growing, but its currency is strengthening against the dollar.

Reuters / File

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Inflation in China rose to a new high of 3.5% in August, while the rate of growth of industrial production, retail sales and money supply accelerated again after having decelerated for several months. This suggests that the Chinese economy might not be slowing as much as many have forecasted.

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The fact that inflation is accelerating and is higher than in the United States also implies that the real exchange rate of the yuan is continuing to rise even though the nominal exchange rate haven't increased so much. While the U.S. August inflation numbers aren't available yet, the inflation rate was 1.2% in July.

Assuming this stays unchanged in August, this implies an inflation differential of 2.3%. Together with the 1% nominal appreciation since the slight June modification of Chinese currency policy, this implies a real appreciation of 3.3% during the latest year.

While it is up to Chinese policy makers to decide to what extent this will involve nominal appreciation, real appreciation is over a longer period inevitable, not because of posturing by U.S. politicians, but because of the Penn effect and because high money supply growth will in the long run follow from high reserve growth caused by currency intervention.

However, since the Penn effect involves a relative price increase of non-tradable goods and services over tradables, and since it is the prices of tradable goods and services that matters for international competitiveness, this may not mean that Chinese competitiveness will decline very much.

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