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Will China succumb to International Pressure to revalue its undervalued Currency – Yuan?

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On March 11, US President Barack Obama urged China to move toward a more “market-oriented exchange rate”. On March 12, a renowned Economist Paul Krugman said that the global growth would be about 1.5% higher, if China stopped restraining the value of its currency and running trade surpluses.

China-Dragon

To add to the Chinese woes, further pressure to review the exchange rates came from the side of international bodies like IMF and WTO urging China to increase its focus on its domestic-led growth.

Yuan pegged Lower to the Dollar

When some of these statements come from the top-most authorities like the President of US, China is sure to meet increasing pressure to revalue its undervalued currency – the Yuan. The U.S. lawmakers believe that the Chinese yuan is undervalued on account of massive foreign-exchange intervention by China to keep its currency pegged lower to the dollar.

China sets the value of yuan with in a narrow range of fluctuation against the major global currencies like euro, yen, etc. and all the more tightly aligned with respect to US dollar. More recently, China has pegged the yuan in a narrow range at near about 6.83 to the dollar since the mid of the global financial crisis. Some of the renowned analysts in U.S. believe that China’s yuan is undervalued by 20-25%.

At the same time, China remains a major exporter of low-cost goods to the world economy; especially the US, which accounts for China’s second largest market in terms of trade. China is the world’s biggest holder of forex reserves which currently stands at a whooping $2.4 trillion.

In order to correct this policy irregularity, China needs to bring down the stake in its holding of dollar denominated assets and, preferably, shift its spread of foreign exchange reserves into some other currency reserve or even safe heaven like Gold.

This could well pave way for strengthening of yuan pegged against the dollar. However, this step would translate into volatile fluctuations in the fortunes of the US in negotiating with its ballooning current account deficit, which are currently remains funded by Chinese surplus reserves.

Cheaper Chinese Exports = Rising US Unemployment

The step to artificially undervalue the yuan as pegged to dollar leads to double advantage to Chinese exports in keeping wage costs lower in dollar terms and also remitting their exports cheaper than the domestic production in the struggling US economy.

After recently witnessed global recession, the struggle for the US economy has increased in terms of rising unemployment and falling exports. At the same time, the widening current account deficit of the US economy is expected to receive no boost from the Chinese imports which floods the US markets with its cheap products.

These imports are, in fact, rendered even cheaper with the undervalued currency of China, which in turn further worsens the unemployment on the back of lack of demand for domestically produced goods. This leads to unfair edge to China in terms of its ever-expanding trade and exports. In fact, this is the same complaint being shared by many countries regarding the stiff Chinese policy to boost its exports.

Interestingly, the dollar is set to depreciate sooner or later over medium term horizon, in light of the burgeoning fiscal stimulus provided by the US government in the light of recent recessionary environment.

That could mean if China continues to move with its policy to align and peg the yuan’s value to the US dollar, it may have to depreciate yuan’s value in line with US dollar fluctuations. This may lead to depreciation of yuan against other major currencies like euro and yen, if the process of actual price discovery is not intervened by the government.

China’s Gradual Intent to Revalue Yuan

According to a report on Reuters,

“A bipartisan bill introduced in the U.S. Senate on Tuesday aims to press Beijing to let the yuan rise, threatening a deepening rift between the world’s biggest and third biggest economies.”

If the US lawmakers arrive at conclusive evidence that China has artificially pegged it currency lower to the dollar, the authorities may contemplate sterner measures like imposing import duties to combat price differential disadvantage rendered to their domestic producers.

According to a latest report on Bloomberg,

“China is conducting yuan stress tests for 12 industries through which the government is testing the ability of companies to withstand a stronger currency.”

At the same time China is also attracting a major flow of inbound capital, while reviving from the global slowdown, which raises the expectations of gradual strengthening of yuan if backed by less regulatory intervention by Chinese authorities.

Inflexible exchange rate policies can lead to global imbalances more so when it is adopted by the giant economies like China, which constitutes a large chunk of its surplus at the expense of other nations, where the dragon economy provides its cheap exports and thus ruining the domestic regional market and raising fears of unemployment in the region.

One solution to this could be a gradual shift in the regime where there is non-reliance on any specific country’s currency while creating a common benchmark currency for global trades. Just, for example, the EURO has served as a common currency for most of the European nations for their internal trades, since quite some while now.

Will China succumb to the international pressure to revalue yuan? What Say?

  1. Abhilash Kushwaha says

    I believe Obama’s statement is just posturing for his domestic audience. I doubt revaluing Yuan will have any impact on US trade deficits.

    In 80’s there was backlash against Japanese and concerns that Yen was under-valued. Since then Yen has gone from 300 Yen / 1 $ to 100 Yen / 1 $. But, US still runs a trade deficits against Japan.

    To sell products you have to actually make what people want for the price they want. Trade restriction is certainly not the way to achieve it.

    1. Viral says

      Hello Abhilash Kushwaha,

      Your point of view is very well taken in that trade restriction is not the way to bring down a country’s economic deficit.

      That apart, what is working at a disadvantage to US domestic manufacturers is that cheaper Chinese imports into the country is rendered even more cheaper on the back of undervalued Chinese currency – the yuan.

      Since China is one of the biggest exporters to the US, it could go a long way in shoring some expectations on the front of revaluing of Chinese currency.

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