ABSTRACT
Since the reform of the RMB exchange rate on July 21, 2005, the appreciation of the RMB has already exceeded 3 per cent, which is higher than other currencies in the world. According to an impossible trinity proposition, China would enjoy more autonomy in monetary policy after employing the managed floating exchange rate regime. By the end of 2005, China had a huge trade surplus of $1029 hundred million; notably, that of the US was closer to 10 per cent of China’s GDP. The foreign exchange reserves also attained a new record of $8189 hundred million, of which two thirds are dollar assets. These facts indicate that Chinese monetary policy autonomy is still facing the big challenge of sterilizing the large amount of foreign exchange reserves which have resulted from these huge twin surplus, at least in the short term. Up to now, it seems uncertain as to whether the Chinese government can steer a more autonomous monetary policy through this reform, and the appreciation pressure on the RMB is not decreased but increased by international society. Many scholars argue that there is some resemblance between the Chinese economy and the Japanese economy of the late 1970s and the early 1980s (for example, Liu and Otani, 2004).2 In a word, the floating exchange rates and increasing free flow of capital substantially increase the risks for the economic system.
