The changing of exchange rate is a way to offset the deficit on current account, which means the government can depreciate the currency value to promote export to bring the deficit back to balance. According to the Keynes macroeconomic theory, for a fast growing country , like China , should run a deficit , which imports tremendous goods from all over the world ,such as oil from middle east and Japan, food from south America, technology from EU and Japan, etc. However, during the fast growing period of over 30 years, China surprisingly runs a huge surplus to the world. What is wrong with it? It could not be possible if we do an economic analysis. It would throw the economics into the trash can if it were true!It should have a large of inflow of capital to cover its vast constructions happening everywhere in China!

I got the answer from the macroeconomic class today, which Pro. Galbraith himself said could be wrong, whereas I feel it very solid. Ok, the thing is, the Chinese government controls the capital control, which means they do not allow the foreign capital enter China. However, we do see them happen in China. Where do these capital come? What the Chinese do. They export goods at an inflated price! For example, they sell a piece of equipment at $200, which is only worth $100. Then they use the extra money to buy the assets or whatever. And then how the money appears on the national account? They are reported export earning. So, the truth is, everybody thinks China is running a surplus, but in fact, it is running a huge deficit!!!!!!! Would it be a problem? Sure, the professor said it would not be a problem now, coz it is under the government control. But it is manipulated by the government against the rules. It is going to collapse someday. He said the government would not let it happen before the 2008 Olympics, but it is going to happen someday after it, or maybe before it.

How to solve it? Back to early 1995, Pro Galbraith was in Beijing with the president of U.S. economist committee. They gave suggestions to the Chinese government to liberalize its financial system and market. Then you can get health capital flows. But they did not do it. While is it a good time to liberalize it now to save the market. Definitely NO! It would cause a big chaos. It is better to close down the improper capital flow gradually, which is way harder than liberalize the financial system 10 years ago. But that is the way and price.

We talked a lot more about stock market and currency as well, but the above was the key issue I think . I am so worried and I hope the policy makers in Beijing are aware of it. I hope I can talk to President Hu.