China's exchange rate trap

The moment when China could have made a smooth transition from pegged currency to a flexible exchange rate has now passed

China's exchange rate policy has been roiling global financial markets for months. More precisely, confusion about that policy has been roiling the markets. Chinese officials have done a poor job communicating their intentions, encouraging the belief that they do not know what they are doing.

But criticising Chinese policy is easier than offering constructive advice. The fact is that the government no longer has any good options. No question, the country would be better off with a more flexible exchange rate that eliminated one-way bets for speculators and acted as an economic shock absorber. But the literature on "exit strategies" - on how to replace a currency peg with a more flexible exchange rate - makes clear that the moment when China could have navigated this transition smoothly has now passed.

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