Respond to this students discussion response: The United States’ dollar is the l

Question

Respond to this students discussion response:

The United States’ dollar is the largest reserve currency, so many countries use it to stabilize their exchange rate through pegging. By using a currency peg, business planning and importation becomes more predictable. China operates on this system, but they intentionally weaken their currency in order to lower the prices on exportation below that of their competitors. U.S. companies that rely on advanced planning on manufacturing or large chain-stores can benefit from China’s pegging, but on the other hand, an artificially low currency disrupts competition, minimizes currency fluctuations, and ultimately affects true supply and demand.

Because of this system, there has become an imbalance of import/export between the United States and China. An enormous, and ever-growing trade deficit is looming as U.S. exports are unattractive in China, and there is an excess of Chinese exports in the U.S. China uses the money it receives for purchases, to acquire safe U.S. Treasuries, and in doing so, the dollar becomes stronger, and it ultimately lowers the yuan's value.

Theoretically, if the dollar were weaker, as it was throughout the recession, the United States’ exportation would be cheaper and would reducing the deficit. As it stands now, even with a weaker dollar, the U.S. cannot compete with China’s pegging system. According to Crawford (2005), “if the yuan were allowed to float against the dollar, the yuan would increase in value by as much as 30 percent…and the trade deficit should narrow.”

This all sounds well and good to change China from a pegging to a floating currency, but it isn’t that simple, nor is it something that could happen overnight. While the appreciation of the yuan may increase U.S. exports, there may be less of a Chinese demand for our treasuries. Some industries may fare well from the change, but chain stores and manufacturing may be on the disadvantaged side. Increasing costs could be passed on to the consumer. Also, exportation and manufacturing is a significant part of China’s GDP, and stifling them could affect the Chinese unemployment rates, and their own housing bubble. This situation should be navigated carefully and slowly to give the economy and market time to adjust. A change like this will cause a ripple effect.

Explanation / Answer

Pros of allowing the Yuan to Float

Cons of a Rapidly Appreciating Yuan

The bottom line is that any change will happen only gradually, which should give the market plenty of time to digest the economic effect one way or the other

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