I have, in the past, alluded to work-in-progress by my colleagues Pat Higgins and Owen Humpage that has significantly colored the way I look at the whole issue of Chinese exchange rate policy and its likely effects on the U.S. economy. The work is in progress no more, appearing in the form of two new Economic Commentary articles from the Federal Reserve Bank of Cleveland. The first deals with the impact of yuan-appreciation/dollar-depreciation on trade conditions. The second discusses nondeliverable forward contracts, and what we can learn from these contracts about market participant's estimates of the renminbi's future value.
Here is the key conclusion from the first article:
China's recent devaluation and liberalization of its exchange-rate policies will, at best, have only a temporary impact on its trade competitiveness with the United States. The type of exchange-rate regime that a country adopts matters little for its long-term international competitiveness. In addition, the recent focus on China's exchange rate diverts attention from the real problem: China’s command economy.
Higgins and Humpage come to this conclusion about liberalization of China's capital markets:
In general, Chinese policies favor net inflows of foreign direct investment,encourage exports over imports, and —most importantly— discourage other types of private financial outflows, largely by limiting the amount of dollars that China’s residents might hold and their ability to invest in foreign assets. Remove the restraints and corresponding policies, and the demand for renminbi will fall relative to the supply and domestic prices will rise.
In other words, the pressure will be in the direction of renminbi depreciation. This conforms to former Commerce Department undersecretary Grant Aldonas' view of things. It decidedly does not conform to Brad Setser's.