The People's Bank of China must choose between preserving domestic price stability and defending the yuan's fixed exchange rate as it is not possible to hit both targets at once, an adviser to the central bank said on Sunday.
In order to defend the exchange rate, the central bank has to buy foreign exchange flowing into China every day, Zhou Qiren, a newly appointed academic member of the PBOC's monetary policy committee, told a forum.
That leads to an excessive supply of base money, and that has been a problem for China since 2003.
Zhou, who heads the prestigious China Center for Economic Research at Peking University, said China's exchange rate regime was the root cause of the country's economic problems, and had yet to be addressed.
You can't ask central bank to look after both price stability and exchange rate stability -- there should be a distinction between the two, he said.
Zhou said the current practice of getting the central bank to issue yuan to buy dollars masked the real cost of holding down the exchange rate.
China's central bank is not only the lender of last resort but also the ultimate buyer of foreign exchange. It is paying the highest price to maintain so-called exchange rate stability, he said.
To avoid excessive money supply growth stemming from central bank intervention, Zhou said China should use fiscal revenues to buy foreign exchange flowing into the country if it wanted to maintain a stable exchange rate.
He said priority should be given to avoiding excessive money-printing in order to maintain the yuan's internal value.
That is more important than anything. It is in China's long-term interest and the interest of the Chinese people.
Zhou, who urged China to make bolder market-oriented reforms on the exchange rate and interest rates, said he was speaking as an academic. He was blunt in his assessment of the influence of the PBOC panel he had just joined.
To my understanding, the monetary policy committee is just an advisory body rather than a decision-making one. It does not decide any monetary policy. It is just a forum for discussion with four meetings a year, Zhou said.
Please don't think that, since I am a committee member, what I say here will have an impact on monetary policy, he added.
The PBOC is just one arm of the State Council, the top administrative organ. Major political decisions such as a change in the currency regime are taken by the leadership of the ruling Communist Party and executed by the State Council.
As to whether the central bank in China can make a final decision on monetary policy, anybody with common sense knows the right answer, Zhou said.
(Reporting by Zhou Xin and Alan Wheatley; Editing by Jonathan Hopfner)