The Renminbi Appreciates, Will China Follow Japan Into Deflation And A Zero Interest Rate Trap?

Since 1999, China's trade surplus has accounted for the maximum proportion of US's total trade deficit. Facing the trade deficit expanding unceasingly, the American complaint undervalued renminbi helps China to obtain the significant competitive advantage in the global market, so America put pressure on China to appreciate the renminbi against dollar. But it is helpless. The currency is not a primary cause of China's trade surplus and has very little to do with the bilateral United States-China trade deficit. What really caused the bilateral China-United States trade surplus is the imbalance of saving and investment continuously in the long run, in China and US. This paper empirically studies the pass-through of RMB exchange rate changes to domestic price, and after amending the theory of uncovered interest-rate parity, studies the effect of RMB exchange rate changes to domestic interest rates. The conclusions are that the appreciation of RMB against dollar will bring downward pressure on CPI and interest rates. If RMB continues appreciating, China will follow Japan into deflation and a zero interest rate trap.How can China avoid falling into that predicament like what happened in Japan? The best solution is for China to shift away from export- and investment-led growth to more of a consumer-driven dynamic. But now, China is suffering from inflation, which was primarily caused by the rise of food price. But the rise of food price can't last. China should pay much attention to the inflation generated by excess liquidity. When hot money flows into China, to avoid an upward exchange rate spiral, the People's Bank of China (PBC) must buy dollars in foreign market. And its consequence is that the PBC expands its domestic money supply. This may let China fall into the liquidity inflation. It is time for the PBC to set a new and much wider, per day, fluctuation limit for the RMB against the dollar.