Assessment on RMB valuation – a triangular analysis approach

<jats:sec><jats:title content-type="abstract-heading">Purpose</jats:title><jats:p>– The authors make assessment on RMB valuation and to contribute to the fierce debate on this important issue, which is perceived to have a great effect on the improvement or deterioration in trade balance. A triangular analysis approach is put forward and empirical assessment is made. The paper aims to discuss these issues.</jats:p></jats:sec><jats:sec><jats:title content-type="abstract-heading">Design/methodology/approach</jats:title><jats:p>– A triangular analysis approach based on no arbitrage conditions for three currencies, and causality and influence analysis.</jats:p></jats:sec><jats:sec><jats:title content-type="abstract-heading">Findings</jats:title><jats:p>– First, it has been found that the movements in the RMB dollar exchange rate do influence the dollar euro exchange rate and the former do have a causality effect on the latter, in both the long run and the short term. Second, it is implied that the RMB is overvalued<jats:italic>vis-à-vis</jats:italic>the US dollar, as the analysis suggests that an overvalued euro<jats:italic>vis-à-vis</jats:italic>the US dollar would imply a kind of overvaluation of the RMB<jats:italic>vis-à-vis</jats:italic>the US dollar, and by any conventional measures the euro has appeared to be overvalued<jats:italic>vis-à-vis</jats:italic>the US dollar, especially in the months before the last financial crisis.</jats:p></jats:sec><jats:sec><jats:title content-type="abstract-heading">Practical implications</jats:title><jats:p>– First, the peg of the RMB to the US dollar that undervalues the RMB<jats:italic>vis-à-vis</jats:italic>the US dollar will not help promote China's overall trade balance or export even if undervaluation of currencies can ever help improve nations' terms of trade. Second, no stability in RMB exchange rates can be claimed by pegging the RMB to the US dollar, as the exchange rate of the RMB<jats:italic>vis-à-vis</jats:italic>currencies other than the US dollar would be as volatile as that between the US dollar and the euro and other convertible currencies.</jats:p></jats:sec><jats:sec><jats:title content-type="abstract-heading">Originality/value</jats:title><jats:p>– A new triangular analysis approach in international finance research. First, there is an advantage to adopt this seemingly simple analytical framework: it is highly reliable; no triangular arbitrage conditions have to be met even under exchange controls, whilst PPP may not hold even with flexible exchange rate regimes. Second, it does away with the thinking confined to small open economies that has dominated academic research for so long and is totally inapplicable to the RMB case.</jats:p></jats:sec>