Case Study A Yen for Yuan Essay
1. China is trying to hold down the value of the yuan because the Chinese government believes that the appreciation of their currency can cause serious challenges to its export industry, as the price of the exported goods will increase causing the demand for Chinese goods worldwide to weaken and eventually causing serious unemployment in the country. The most obvious sign that China is pursuing a weak currency policy is shown by the Chinese Central Bank had been maintaining a fixed exchange rate for years.
Now China’s Central Bank adopted a managed float where it simply sells the yuan and buys vast amounts of dollar reserves. 2. China expects to benefit from a weaker currency by simply keeping the country’s main driver of growth, exports going strong. China needs a weak yuan to continue achieving its remarkable growth and keeping its products prices incredibly low worldwide. 3. American consumers would be paying $55 billion more annually for the $200 billion of Chinese products it imports if a tariff of 27. 5% would be imposed.
This of course would allow domestic products to compete with its Chinese counterparts but could spark a huge trading war. 4. The yuan appreciating 25% would lead to a 25% depreciation of the dollar. Chinese products being more expensive leading to the domestic products being more competitive and the appetite for the Chinese goods dropping in favor of domestic products due to the currency exchange. 5. The Central Bank of China tries to maintain the yuan artificially lower by selling yuan and buying up all the foreign currency inflows.
The main problem with this monetary policy is that the money supply for the yuan is rising fast and this could cause massive inflation in the long term. The Chinese government will have to raise interest rates in order to keep inflation from going through the roof. 6. The main cost an undervalued yuan imposes on the Chinese economy is that foreign trading partners such as the United States and the European Union might shift towards protectionist trade policies against China by placing tariffs on Chinese goods. . If the Chinese government were to allow the yuan to appreciate to a rate of 5 to 1 dollar from 8. 11 to 1 dollar an investor that would measure gains in dollars would amount a loss instead of a gain due to the value of the dollar depreciating against the yuan.
8. If China were to allow the yuan to become a convertible currency this would make the demand for the yuan to drop significantly and this would cause the yuan to depreciate against other world currencies. 9. On July 21st, 2005 the Yuan appreciated 0. 7 against the dollar which in percentage terms would be roughly 2%. 10. In May 18, 2007 China announced that it was expanding the trading band for the yuan to plus or minus 0. 5% from the previous 0. 3% this has affected the U. S trade deficit with China in a positive manner as it allowed the yuan to strengthen slowly. At the time of the publishing of this book 1 dollar was equal to 8. 11 yuan, due to increased pressure from all global powers the yuan has strengthened being that 1 dollar equals 6. 65 yuan today.