Foreign clamour to allow the RMB to appreciate seems have mellowed a bit recently, even though the upcoming US presidential election is going to make the Sino-US trade an issue as usual.

On July 31, US President George W. Bush vowed in the unemployment-riddled state of Ohio to protect overseas US interests and issued a demand for China to stop pegging the RMB to the greenback.

Yet a week later, US treasury secretary John Snow told business leaders in Pittsburgh that Washington's lobbying for a more flexible Chinese currency policy has made breakthrough, particularly since China needs to curb inflation.

Predictably, the United States will continue creating a din over RMB exchange rates. But the intensity has dramatically lessened from a year ago.

It is partly because the Bush administration's dialogue-based "soft" touch is taking effect. Another reason is the presidential election is going to create tension in many other aspects and therefore eclipse the friction over the RMB.

Some Japanese financial media also provide other perspectives. First, with US interest rates going up, China is likely to raise domestic interest rates as well, which to an extent is equivalent to increasing the exchange rate.

Also, China has witnessed a US$7 billion or so trade deficit in the first half of this year, with few signs the entire year will end up with a surplus. It is hardly convincing to require an economy in a trade deficit to raise its currency value.

From the Chinese perspective, however, the pressure does not decrease because of lessened controversies outside, considering the tough challenges in financial reforms at home.

The administration's currency manoeuvres are related to locally overheated economic growth. In order to maintain the US-dollar-to-RMB exchange rate at 8.28, the financial authorities have to increase currency supply, which has in a sense added to the unbridled growth in some sectors.

Meanwhile, uncertainties in the US dollar have mired China in huge risks and made it vulnerable to large-scale capital flows.

As the recent US interest rate hikes lure in idle money worldwide, it is not unlikely that China will suffer a capital exodus. And once the exodus proves true, any move in monetary policy will be useless, which has been proven by the 1997 Asian financial crisis.

The controversies over the RMB exchange are in effect different outlooks on the Chinese economy and financial situation. But it is impossible for any economy to have such a scenario: an unchanged exchange rate, no inflation and sustained fast growth.

Therefore, China has only three options regarding its RMB exchange rate.

The first is to implement a progressive RMB appreciation scheme right now. This is the best option since it would help avoid inflation and also maintain 7-8 per cent economic growth.

The second option is to keep the status quo. In this case, bubbles will accumulate and eventually burst, impeding the economy and dealing a major blow to businesses who feed on the local market.

The last option is to let the currency appreciate instantly. This will hurt export-oriented manufacturing companies.

US and Japanese policy-makers have announced several times they want Western economies to cling to an agreement to propel RMB appreciation.

The plan is similar to the 1985 Plaza Accord in which Western countries forced Japan into revaluing the yen. Such accords please some countries at the expense of another's economy, and are unacceptable to China.

China has realized that exchange rates can be adjusted. But whether the exchange system is open and the degree of openness depends on the real conditions rather than any foreign country's will.

China can do with a relatively flexible monetary policy considering the economy's competitiveness. But nobody can foresee how far the effect will go if the exchange system is opened right now.

We have reason to believe Western country's RMB appreciation arrangement is only the thin end of the wedge. The revaluation will slow economic growth and increase distressed assets in the financial sector.

Perhaps some day, Western country's will cry out that RMB is "overvalued" on the grounds of Chinese banks' huge bad loans.

A developing country like China will never be able to catch up with developed economies if its currency has to be re-assessed by others from time to time.

Behind the RMB revaluation controversy is the question of free convertibility, which is the real concern of Western countries.

Actually, the United States and Japan are confident that the People's Bank of China, the central bank, will not maintain the fixed exchange rate system, in that the 2008 Beijing Olympics is approaching and there is no way to stick to a fixed exchange rate system.

Many foreign experts are assured that sustained prosperity of the Chinese market will be based on freed-up exchange and trade regulation. This might be a reason that talks on the RMB revaluation are being played down for now.

(China Daily August 27, 2004)