foreign exchange allotment quota, the rate was set at RMB2.80 per USD. Generally speaking, this rate was formed by add ing to the effective rate an"equalization price"for balancing export and import profits and losses, and was applied to all national enterprises and corporations engaging in trade It was also applied to receipts and expenditures in foreign exchange for trade-related transactions in invisibles, such as shipping and insurance The trad ing business was done under an experimental trad ing system for foreign exchange, which was established by the bank of China in a few areas, such as beijing, guangdong Hefei, Shanghai, and Tianjin. National enterprises holding foreign exchange earned through the system of retention quotas were permitted to sell it to other national enterprises that had a quota for spending foreign exchange. For dealings under the foreign exchange retention scheme, the Bank of China acted as a broker, charging 0. 1-0.3 per cent. This process, and a breakthrough was made in the reform of the exchange rate mechanist ming indicates that the market mechanism was introduced into the exchange rate forming On 1 January 1985, the trade-related internal settlement exchange rate was abolished and the effective rate came to govern all trade but a foreign exchange retention quota remained for a portion of export proceeds. On 20 November 1985, authorization was granted for Chinese residents to hold foreign exchange, to open foreign exchange accounts, and to deposit and withdraw funds in fo In November 1986, a foreign exchange swap rate was created, based on rates essentially agreed to between buyers and sellers. This became available for foreign investment corporations at over 100 foreign exchange adjustment centers and for Chinese enterprises in the four Special Economic Zones(Shantou, Shenzhen, Xiamen, and Zhuhai) initially and then in 1988 it was expanded to all domestic entities authorized to retain foreign exchange earnings( World Currency Yearbook 1988-1989). The swap rate and official rate coexisted until the single rate regime was established in 1994 The transition period of 1985-1993 had two features. First, in accordance with the aboy statement, the renminbi had two prices vis-a-vis foreign currencies. The official price of the USD was lower than the swap rate, implying that the renminbi was set artificially high The official rate was basically determined by the exchange cost of export goods plus a certain amount of profit. This is actually a practical application of a theory called tradable goods purchase power parity (Yang Fan, 1999)a variant of purchase power parity Second, the overvaluation of the renminbi made the currency face depreciation pressure, and indeed it followed a path of depreciation. While the official exchange rate and swap market exchange rate were approaching one another before 1992, the economic overheating driven by Deng Xiaopings South China Tour speeded up the renminbi depreciation process and widened the difference between the official rate and swap market rate. Simultaneously, the market exchange rate overshot and the renminbi was severely undervalued, as will be shown in an empirical study below. The integration of the dual exchange rate system in 1994 can be viewed as a continuing effort toward theforeign exchange allotment quota, the rate was set at RMB2.80 per USD. Generally speaking, this rate was formed by adding to the effective rate an “equalization price” for balancing export and import profits and losses, and was applied to all national enterprises and corporations engaging in trade. It was also applied to receipts and expenditures in foreign exchange for trade-related transactions in invisibles, such as shipping and insurance. The trading business was done under an experimental trading system for foreign exchange, which was established by the Bank of China in a few areas, such as Beijing, Guangdong, Hefei, Shanghai, and Tianjin. National enterprises holding foreign exchange earned through the system of retention quotas were permitted to sell it to other national enterprises that had a quota for spending foreign exchange. For dealings under the foreign exchange retention scheme, the Bank of China acted as a broker, charging 0.1–0.3 per cent. This indicates that the market mechanism was introduced into the exchange rate forming process, and a breakthrough was made in the reform of the exchange rate mechanism. On 1 January 1985, the trade-related internal settlement exchange rate was abolished and the effective rate came to govern all trade, but a foreign exchange retention quota remained for a portion of export proceeds. On 20 November 1985, authorization was granted for Chinese residents to hold foreign exchange, to open foreign exchange accounts, and to deposit and withdraw funds in foreign currency. In November 1986, a foreign exchange swap rate was created, based on rates essentially agreed to between buyers and sellers. This became available for foreign investment corporations at over 100 foreign exchange adjustment centers and for Chinese enterprises in the four Special Economic Zones (Shantou, Shenzhen, Xiamen, and Zhuhai) initially, and then in 1988 it was expanded to all domestic entities authorized to retain foreign exchange earnings (World Currency Yearbook 1988–1989). The swap rate and official rate coexisted until the single rate regime was established in 1994. The transition period of 1985–1993 had two features. First, in accordance with the above statement, the renminbi had two prices vis-à-vis foreign currencies. The official price of the USD was lower than the swap rate, implying that the renminbi was set artificially high. The official rate was basically determined by the exchange cost of export goods plus a certain amount of profit. This is actually a practical application of a theory called tradable goods purchase power parity (Yang Fan, 1999)—a variant of purchase power parity. Second, the overvaluation of the renminbi made the currency face depreciation pressure, and indeed it followed a path of depreciation. While the official exchange rate and swap market exchange rate were approaching one another before 1992, the economic overheating driven by Deng Xiaoping’s South China Tour speeded up the renminbi depreciation process and widened the difference between the official rate and swap market rate. Simultaneously, the market exchange rate overshot and the renminbi was severely undervalued, as will be shown in an empirical study below. The integration of the dual exchange rate system in 1994 can be viewed as a continuing effort toward the