You said a true thing and then moved on to act as if the Chinese propping up the dollar has no impact on the US$:€ exchange rate. But of course, if the Chinese peg directly to the dollar, the dollar exchange rate with all currencies it floats against is higher as a result.

That's the way a mixed floating/pegged system working through exchanges works - the floating currency that is the subject of the pegging operations rises in value relative to other floating currencies.

Except when taking sloppy mainstream economic shortcuts involving assumptions un-anchored in reality that in effect assume money neutrality when discussing demand and supply of one currency for another, there are not two pure cases to consider, but four, and in practice countries can adopt mixes of the pure cases:

• Pegging to the dollar, targetting the US$ FXR
  
• Pegging to the dollar, targetting some other FXR
  
• Pegging to something else, targetting the US$ FXR
  
• Pegging to something else, targetting some other FXR
  

It might seem that the second case is just for logical completeness, since we are moving from a period of the West Pacific Rim pegging to the US$ - though it was of course relevant, for example, to the transition from the £sterling to the US$ in the former British Empire in the late 40's and 50's.

China is presently doing a mix of the first and the second, since they adopted a Singapore Peg early in this decade. However, they have the option at any time to switch to mixing all four - for example, shifting the currency basket they peg against to a trade-weighted basket and targetting a stable synthetic FXR against that basket would be a mix of pegging with the US$ and other currencies and targetting US$ and other floating currency exchange rates.

If they switched to that, the floating currencies would be far closer to the situation you imagine, where the pegging operation against one currency does not affect its FXR with the currencies it floats against.

And the Chinese could also switch their target to one that does not include the US$ - they could drop the US$ from their pegging currency basket entirely, or in a less extreme scenario simply shift the focus of their exchange rate management from the RMB¥:US$ to some other FXR, like RMB¥:€

Given that a pegged exchange in a mixed pegged/currency world must be held at a discount in order to be effective - a peg at a premium is subject to speculative attack, draining foreign exchange reserves, while a peg at a discount is of course immune to speculative attack, since capacity to generate domestic currency cannot be drained - pegging countries are net demanders of floating currencies.

Assuming that the currency that they are pegging can be ignored and all that has to be considered is the exchange rate that they are managing via the peg ignores the fact that the same target rate achieved with different currency pegs implies different relative demand for the floating currencies and hence a different exchange rate between the floating currencies.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.