Sir, Paul Cavey and Bill Belchere are right in emphasizing that China's fixed exchange rate is complicating its domestic monetary policy management (“China's exchange rates are a domestic problem”, November 17.)

They are also correct in making the case for a Chinese currency appreciation not simply as a means of defusing rising external protectionist pressures, but as a means of enabling a more independent and effective domestic monetary policy.

A key point they overlook, however, is that a gradual appreciation of the Chinese currency is likely to intensify rather than reduce foreign speculative inflows. By validating speculators' beliefs that the currency can only appreciate, a policy of gradual currency appreciation would in effect be giving speculators a one-way bet on the currency. Such an approach would hardly restore monetary policy independence to China.

If China indeed wishes to regain monetary policy independence, it needs to contemplate a very much more radical approach to currency market reform than it has to date. At a minimum, the currency would need to be allowed float within a wide band and to reach a level that markets might consider an equilibrium level. Until it moves decisively in that direction, China will have to learn to live without an independent monetary policy.

Desmond Lachman is a resident fellow at AEI.