After more than a decade, the Chinese yuan is finally being decoupled from the U

Question

After more than a decade, the Chinese yuan is finally being decoupled from the U.S. dollar. The yuan will now float against a basket of foreign currencies. China has been under increasing pressure from the U.S. to make such a move. In fact, U.S. Treasury Secretary John Snow has complained that continuing to peg the yuan to the dollar was tantamount to subsidizing companies, and threatened retaliatory trade sanctions if China failed to take corrective actions. Analysts, however, note that China is only revaluing the yuan by two percent, so the net effect is negligible given that estimates have the yuan as being undervalued by as much as 40 percent. China is reluctant to make a significant change to the yuan because its economic policy centers on growing exports, and the undervalued yuan amounts to a 33 percent subsidy to exporters. Eliminating the “subsidy” results in a loss of competitiveness for Chinese exporters, and an increase in competitiveness for American exporters. The question now is whether China will take steps to further revalue its currency. Analysts seem to believe that political pressure and internal pressures will force China to continue to continue to revalue its currency, a move that could have repercussions in other parts of Asia. There is also some concern that inflationary pressures will rise in the U.S. if China makes any significant moves to revalue its currency. This video fits in well with the material on the IMF and the global capital market. In addition, it can be used to supplement the discussion of instruments of trade policy. Discussion Questions 1. China, which has been under strong political pressure for some time to revalue its currency, has finally agreed to do just that, only in a very small way. Is this move by China a win for the U.S. or a win for China? What are the political implications of this action? 2. Until now, China’s currency valuation has represented a significant subsidy to Chinese exporters, a situation that is seen in a negative light by American exporters. However, as a beneficiary of cheap goods made in China, how do you feel about the U.S.’ efforts to force China to raise its currency? 3. After more than a decade, the value of the yuan has risen relative to the dollar. While the revaluation amounts to just a two percent difference at the moment, there is speculation that the Chinese will continue to allow the yuan to rise. What effect will this initial movement have on Chinese workers and consumers? What are the effects if the yuan continues is ascent? 4. China’s revaluation of the yuan was echoed in other parts of Asia. For example, in India, the rupee appreciated, as did the Japanese yen. Consider the implications of further currency revaluations for the Asian region.

Explanation / Answer

1. China's revaluation of currency means that the currency is becoming expensive and hence for Chinese exporters, this might lead to loss in sale for them as the goods become expensive because of revalued currency. This will lead to larger current account deficits with China for countries importing from China, one of them being America. Politically, the US has been pushing the move ever since, it seems that US will also be a loser. The loss to consumers because of revaulation has to be offset by the win for producer's competitiveness. Even for China, the revaluation would lead to the win for the economy only if the loss in the exports are met by the increase in domestic demand for Chinese goods. US political policymakers have been blaming Chinese cheaper goods for loss of employment in the US economy and hence the move is politically derived from the large unemployment rate and trade imbalance in US

2. The current currency valuation of remnibi has led to cheaper chinese goods floating in the international market leading to losses for the American exporters as claimed by the US. But as a consumer, it is a significant loss as Chinese exporters will now lose on foreign demand as the prices of goods will rise because of expensive currency. US goods are relatively expensive in terms of production so it would require a larger revaluation in the Chinese currency to offset the relative cheaper position enjoyed by chinese goods and only then can the American exporters benefit from the situation.

3. Continued increase in the price of yuan will lead to higher prices of goods and exporting firms might lose their competitive advantage because of the step. It was believed that chinese undervalued currency was exporting unemployment to the rest of the world. Hence, now with this move it can be expected that the chinese workers in the exporting firms might get impacted and face a fall in wage or loss of job. Consumers would also get impacted because of the rising prices of goods.

4. As Chinese currency revalues, the impact on Asian currencies, some of which will follow the chinese revaluation as per different studies has been estimated to initially depreciate but the changes would be small. The total changes in exports for economies are small largely due to price effects once changes in the real exchange rate are considered. This will lead other economies to devalue their currencies to maintain export competitiveness

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