Mar 04, 2014 01:19 PM

The Misleading Argument against Yuan Appreciation

One argument that has been put against appreciation of the yuan (or indeed almost any currency) is that it will create "losses" for the country's central bank on its foreign exchange reserves, which after the appreciation will have a lower value in domestic currency than they did beforehand. This misleading argument against appreciation is given some credence by a recent book, The Dollar Trap, by Eswar Prasad, now of Cornell University and a former official of the International Monetary Fund, in which he suggests that China stands to lose billions on its large dollar reserves if it appreciates the yuan. I will take up the substance of this fundamentally incorrect claim below, but it is useful first to summarize the main message of Prasad's book, since its title is not self-explanatory. Although Prasad shares the widespread view that the current international monetary system is flawed, he also believes, correctly in my view, that the international role of the U.S. dollar is deeply entrenched in the system, that this role will continue for a long time, and that paradoxically although it has some weaknesses, this deep role of the dollar lends a fundamental stability to the system. This view needs to be studied by those who hope or desire that substitutes or alternatives will be found soon.

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