Resolving Government’s Structural Deficit––– 2. Imposition of Inheritance Tax to Widen Tax Base

Background and Introduction

China overhauled its policy of pegging RMB to USD in 2005, which makes RMB peg to a basket of currencies according to trade share. However, the majority of weighting still goes to USD. It means the valuation of RMB is mostly determined by movement in USD, which raises the question of over-reliance on USD and thus the US. So the RMB peg should undergo reform both for strategically and economic reasons. Further 

Before we get into the idea of pegging RMB with a Basket of Commodities, we should assess the most intuitive solution, which is the de-peg everything and make the RMB a fiat currency just like the USD or Euro. The fiat currencies have several problems that make it an inferior alternative to pegging against a basket of currencies. First, it is subject to speculative and unfavorable attack, which hinders the prospect of freeing capital inflow and outflow. Second, from the lesion of USD, fiat money means the government has to rely on interest rate adjustment to protect its value and implementation of monetary policies. Such reliance on interest rate to implement monetary policies will distort the interest rate as an important price signal in a market economy.

Hence, should the Chinese government intend to lift the capital flow restriction or reduce the reliance on USD, we need to find alternatives to the fiat money choice. And pegging RMB with a basket of commodities, a creative and sensible proposition by Steven N.S. Cheung, is worth considering.

Implementation

First, choose a basket of 20-40 commodities such as crude oil, corn, grain, soybean, wheat, cotton, and more. Second, make each individual commodities chosen a RMB-denominated futures market. Third, make an index of commodities weighed by the trading value of each commodities in the beginning of a year. The weighting will be re-calculated once each year. I propose that the index should start with 10K and imitate Hong Kong’s way of managing such peg. For instance, the index is 10K and allow for a fluctuation range of 9500 to 10500 (which can be adjusted when the government wants inflation or deflation) In practice, when the RMB rises above the upper range of 10500. The government can implement deflation by selling futures contract of the basket of commodities and thus devaluing the index and contracting RMB supply in the market. Similarly, when the RMB devalues to a lower range of 9500 the government can implement inflation when the RMB sinks above the lower range of 9500 by buying the futures of the basket of commodities and receiving back RMB until the index re-balance to 10000. The government can implement inflation by buying futures contract of the basket of commodities and thus devaluing the index and contracting RMB supply in the market. And again the index will be re-balanced each year weighted by the trade value of each commodity in the previous year.

Advantages of Pegging RMB with a Basket of Commodities

1. The government does not need to hold the basket of commodities physically (unlike other pegs like Hong Kong’s peg to USD, which needs to accumulate a USD currency reserve to defend the peg), as trading on the futures market is sufficient in defending the peg.

2. It releases the reliance on USD and other major currencies like Euro, JPY, and other G10 currencies. RMB can finally compete with the major currencies, mostly the USD. There is every chance that other smaller economy can peg with the RMB, since it has something concrete (commodities), unlike other fiat currencies like the above mentioned.

3. Interest rate will be fully determined by the market, as the government no longer needs it to implement monetary policies. As interest rate is an important price (of capital), handing it back to the market to determine will be the best practice. Fiat money needs to adjust the interest rate time to time and distort this important price signal.

4. Foreign Reserve will no longer be needed. This means the close to USD3 trillion foreign reserve can be gradually sold in the market, releasing a huge amount of capital for the market or state-owned enterprises.

5. China will be ready for lifting the capital inflow and outflow restriction, as the peg to a basket of commodities is difficult to speculate or launch vicious campaign on. As the basket of commodities is denominated in denominated in RMB, which means China can simply print money to finance the deflation or inflation according to the index, China is the biggest player in these commodity markets and speculative attacks on the RMB is minimal in chance, for the speculators need to simultaneously manipulate 20-40 commodity markets, which cannot practically be done.

Role of Hong Kong and CNH

As such reform in RMB or CNY markets are too risky and large to implement. It is best to experiment the policy with a smaller offshore RMB currencies Therefore, It is where Hong Kong can step in as the largest trading center of the offshore RMB currency of CNH. The Central Government can simply monitor how the CNH market, which is pegged to the basket of currencies, in order to determine whether to implement this peg with the on shore CNY

It will be a showcase of how Hong Kong can help China’s development under One-Country- Two- Systems.