China is facing a major inflation problem as they try to prop up the dollar to remain an exporter.
http://online.wsj.com/article/SB10001424053111904006104576504530862536132.html?mod=googlenews_wsj
Last week China allowed the value of the yuan to rise against the dollar by 0.8%, which may not sound like much until one considers that the currency's total appreciation so far this year is 3.1%. The move created speculation that Beijing is strengthening its currency to fight inflation, which hit a new three-year high of 6.5% in July and has authorities worried about social stability.
More figures emerged last week to support this inflation-fighting theory: In July, bank lending slowed dramatically, and growth in the M2 money supply is at a six-year low. Beijing is using direct control over the banks, rather than interest rates, to curtail lending. But many doubt it can keep such strong measures going for long, since giant state-owned enterprises and small private firms alike are screaming for credit. With inflation still rising and the economy slowing, there are fears of a hard landing.
So China's leaders may see a stronger yuan as the easiest way to fight inflation. There is irony here, since they have long resisted outside pressure to take precisely this path. Now they could end up placating U.S. Senator Chuck Schumer and other protectionists in Washington. That should be a strong clue that revaluation is a bad idea.
The real solution to rising inflation and slowing growth is more efficient use of capital, which in China's case means liberalizing the banking system. Currently the state sets a low floor on deposit interest rates, so that households are deprived of income from their savings, and it sets a ceiling on lending rates so that the state-owned banks make a healthy margin whomever they lend to.
For the last two years the government has ordered the banks to expand lending to the state-owned enterprises to keep growth going after the global financial crisis. Now the bankers are being told to rein in credit, and they naturally choose the safe option, lending to those same enterprises to keep them afloat. While private entrepreneurs have to close down or borrow from loan sharks at usurious rates, future bad loans continue to pile up at the banks.
Market-oriented lending would allow the government to better regulate the economy using interest rates, as it could fight inflation without cutting off credit to the most productive enterprises. Some at the central bank know that this is the way forward. Statistics chief Sheng Songcheng published an article last Monday that advocates relaxing the restrictions on deposit and lending rates.
Competition among banks to fund the best companies would give private firms access to capital and impose discipline on the state sector, and that would create more new jobs and raise productivity. Inflation would be less of a concern as it would reflect higher real wages. And as prices rose, China's trade surplus would tend to fall.
So China doesn't need currency revaluation to resolve the imbalances that have led to its massive trade surplus, which surged again last month, as well as the accumulation of a staggering $3.2 trillion in reserves. Letting the yuan appreciate may look like the easy way out. But currency stability has been one of the keys to China integrating with the global economy. Embarking on the next round of market reform will bring more lasting value to the yuan.
Please Scroll Down to See Forums Below 
