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Sunday, June 01, 2008

China's foreign exchange reserves reach $1.76 trillion

 
More speculative money are flowing into China in anticipation of further Yuan appreciation, even with capital control.  Chinese policy makers are facing a dilemma.  They will soon realize only by appreciating the currency thus reduce trade surplus won't solve the inflation problem.  This is because foreign capital continue to flow in (those hot money), and money supply still increases.
 
There are two ways out of this.
 
First, raise interest rate sharply to cool down the economy and fight the greater inflation evil.  Be reminded, this may encourage more carry-trade toward China, so effective capital control is essential.
 
Or, re-evaluate Yuan in an one-shot fashion and be done with it.  This requires much greater political courage and may hurt exporters a great deal.  For this reason, I think raising interest rate is more prudent policy choice.