Targetting Currencies?

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  • #18628
    tommyjbehnke
    Member

    Professor Herberner,

    Saw in the news today that China is looking to tie the renminbi to a basket of currencies instead of the U.S. dollar exclusively (http://www.nytimes.com/2015/12/12/business/international/china-to-track-renminbi-based-on-basket-of-currencies.html).

    However, I recall reading an old article from Gary North that said this isn’t possible:

    “Today, a government tells the central bank to establish a trading range for the nation’s currency. The central bank can only target one currency at a time. If it chooses one currency to match, it loses control over the other currencies’ ratios. The central bank inflates at a rate different from the targeted nation’s central bank: probably the Federal Reserve System. The dollar is still the target, for Americans import the most goods. We run the largest trade deficit.”

    Do you agree with Dr. North? If so, can you please explain?

    Thanks so much!

    #18629
    jmherbener
    Moderator

    Exchange rates are the actual prices that exist among different currencies. Market baskets are makeshift computations and not market prices. Suppose there is a market basket made up of one Yen and one USD against which changes in the market-basket value of the RMB is to be determined. If the RMB appreciates 10 percent against the Yen and depreciates 15 percent against the USD, then the market-basket value of the RMB would decline 5 percent. If the Bank of China desired to keep the market-basket of the RMB stable it would have to sell RMB for Yen to devalue the RMB by 10 percent and buy RMB with USD to appreciate the RMB by 15 percent. If instead, the Bank of China sold the market-basket for RMB to appreciate the RMB by 5 percent against the market-basket, it would leave the RMB overvalued against the Yen and undervalued against the USD.

    #18630
    tommyjbehnke
    Member

    Great explanation. Thanks so much.

    I’ve read that they decoupled the RMB from the USD because they don’t want to keep up with the strengthening dollar anymore…instead of trading so much with the United States and buying up so many U.S. Treasuries, they now want to focus on their local trading partners who have looser monetary standards.

    Why do you think they decided to tie it to such a diverse basket though? Is it because they need to finance debt from many countries in order to keep up with what they used to purchase from the United States? Therefore, they have a vested interest in multiple currencies and need to do what they can to stay tied to all of them?

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