The United States Federal Reserve's latest interest rate hike has imposed pressure on the yuan in terms of its exchange rate with the US dollar. This time, though, the People's Bank of China did not follow the Fed to raise China's domestic interest rates. Instead, it has continued its monetary expansion aimed at easing the tension in its credit market recently. After one and a half years of anxiety over capital flight, the central bank has regained its confidence to implement an independent monetary policy.

The fixed exchange rate regime helped China to maintain competitiveness from 1994 to 2012, a period when it relied on exports for fast growth. During that period, China's industrial sector experienced stunning growth in labor productivity. One worker around 2010 was equivalent to 12 workers in the early 1990s.

The growth was much bigger than that in the non-tradable sector, although the latter was remarkable - one service worker around 2010 was equivalent to four service workers in the 1980s. The Balassa-Samuelson effect, which depends on inter-country differences in the relative productivity of tradable and non-tradable sectors, then dictates that the yuan would experience real appreciation, that is, either its nominal value would increase against the currencies of China's major trading partners, or China's domestic prices would increase.