Over the past five years China has emerged as the world's largest global surplus economy; indeed by 2007–08 the size of its surplus relative to its GDP was of a magnitude unprecedented for a large trading economy. This development is especially surprising since in the first twenty-five years of economic reform China's trade and current account surpluses were quite small by East Asian standards, averaging less than 2 percent of GDP.

This study provides a comprehensive analysis of the key economic challenges facing the Chinese authorities in light of the still undervalued exchange rate, the large build-up of foreign exchange reserves, and more recently the sharp decline in economic growth.

It analyzes the implications of China's exchange-rate policy for the effectiveness of monetary policy, the transition to a commercially oriented banking system, the evolving structure of output and demand, and the risk of protectionism abroad.

The policy-options portion of the study takes account of the significant real effective appreciation of the renminbi over the past fifteen months and will contrast the pros and cons of a "stay-the-course" policy with that of a bolder, "three-stage" approach that would seek to maintain recent progress and to reduce even further the undervaluation of the renminbi.

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The Future of Chinese Exchange Rate Policy
Policy Analyses in International Economics 87
Morris Goldstein and Nicholas R. Lardy
ISBN paper 978-0-88132-416-7
July 2009 | 133 pp. | $20.95

ABOUT THE AUTHORS
Morris Goldstein, Dennis Weatherstone Senior Fellow since 1994, has held several senior staff positions at the International Monetary Fund (1970–94), including deputy director of its Research Department (1987–94).

He is the author of Managed Floating Plus (2002), The Asian Financial Crisis: Causes, Cures, and Systemic Implications (1998), The Case for an International Banking Standard (1997), and The Exchange Rate System and the IMF: A Modest Agenda (1995), coeditor of Debating China's Exchange Rate Policy (2008), and Private Capital Flows to Emerging Markets after the Mexican Crisis (1996), coauthor of Controlling Currency Mismatches in Emerging Markets (2004) and Assessing Financial Vulnerability: An Early Warning System for Emerging Market (2000), and project director of Safeguarding Prosperity in a Global Financial System: The Future International Financial Architecture (1999).

Nicholas R. Lardy, senior fellow at the Peterson Institute for International Economics since 2003, was a senior fellow in the Foreign Policy Studies Program at the Brookings Institution from 1995 to 2003. He was the director of the Henry M. Jackson School of International Studies at the University of Washington from 1991 to 1995. From 1997 through the spring of 2000, he was the Frederick Frank Adjunct Professor of International Trade and Finance at the Yale University School of Management.

His publications include Debating China's Exchange Rate Policy (2008), China's Rise: Challenges and Opportunities (2008), China: The Balance Sheet (2006), Prospects for a US–Taiwan Free Trade Agreement (2004), Integrating China into the Global Economy (Brookings Institution Press, 2002), China's Unfinished Economic Revolution (Brookings Institution Press, 1998), China in the World Economy (Institute for International Economics, 1994), and Foreign Trade and Economic Reform in China, 1978–1990 (Cambridge University Press, 1992).

ABOUT THE PETERSON INSTITUTE
The Peter G. Peterson Institute for International Economics is a private, nonprofit, nonpartisan research institution devoted to the study of international economic policy.

Since 1981 the Institute has provided timely and objective analysis of, and concrete solutions to, a wide range of international economic problems. It is one of the very few economics think tanks that are widely regarded as "nonpartisan" by the press and "neutral" by the US Congress, it is cited by the quality media more than any other such institution, and it was recently selected as Top Think Tank in the World in the first comprehensive survey of over 5,000 such institutions.

Support is provided by a wide range of charitable foundations, private corporations, and individual donors, and from earnings on the Institute's publications and capital fund. It celebrated its 25th anniversary in 2006 and adopted its new name at that time, having previously been the Institute for International Economics.

INTRODUCTION
In the short space of three decades China has transitioned from a largely self-sufficient economy to the world’s third largest trading nation. As its role in the global trading system has expanded, the rest of the world has taken a keen interest in the evolution of its trade regime.

This interest was apparent in China’s negotiation to enter the World Trade Organization (WTO). Members of the WTO leading the negotiations sought to impose conditions that maximized the prospects that China’s entry would occur on “commercially viable terms.” In response, during the 14-year negotiation process China unilaterally cut its tariffs substantially, in large measure to demonstrate its commitment to a liberal trade regime. Since China’s entry into the WTO in December 2001, the members have periodically reviewed China’s compliance with the terms of its commitments.

More recently, China’s foreign exchange regime also has received growing attention from the international community. A rapidly growing external surplus and substantial official intervention in the foreign exchange market, combined with large-scale sterilization of the resulting increases in China’s international reserves, have naturally raised a number of important questions about the nature of China’s foreign exchange regime.

For example, to what extent have the actions of the authorities resulted in an undervalued exchange rate for the renminbi? To what extent are China’s international obligations on exchange rate policy in conflict with its domestic economic priorities? Did China’s large external surpluses contribute to the emergence of the global financial crisis in 2008? Do China’s massive holdings of US treasury obligations and other US dollardenominated financial assets provide China with substantial leverage visà-vis the United States that China might use to advance its own economic and political interests? What role has the International Monetary Fund (IMF) played and what role should it play in overseeing developments in China’s exchange rate regime? ...

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