Revaluation of Chinese Yuan and Its Impact on US

Economy
 
China’s currency exchange system

 Pegged exchange system

 Pegged to US dollar at a constant ratio of 8.3 since 1994
 The pegging is believed to play a positive role in 1997-
1998 Asian financial crisis.
 Significantly undervalued for the last several years
 Pegging is achieved through foreign exchange
intervention
 Understanding

• On Jan 7, 1994 , the chinese gov. fix the value of

the Yuan to the U.S. dollar at a rate of 8.690 per
dollar. On that time it was not considerd as a
major issue.

• Pressure began to built in 2005 , as both the

europian union and the U.S. faced strong
competition from imports from china.
• Many observers believed that the yuan was significantly
undervalued, as China was accumulating large dollar
reserves.

• U.S. producers complained that China’s cheap

yuan gave Chinese producers an unfair advantage.

• President Bush asked China to let its currency float;

Others in the U.S. wanted tariffs on Chinese goods.
• Because of china’s low manufacturing wages, it
was exporting far more to the U.S. than it was
importing.

• In 2004 , china had a trade surplus of $155 billion

with the U.S.
• One major problem with the EU is that as the euro
had grown by 45 percent against the dollar , which
meant it had also grown by 45 percent against the
yuan, which was fixed against the dollar .

• Due to this reason chinese exports had gotten

cheaper against europian products .
• Thus EU and U.S. criticize china and argued that
the yuan was undervalued by 15 to 40 %.

• And the chinese gov. needed to free the currency

and allow it to seek a market level .

• China had its own political pressure because a lot

of people had been moving currency into china in
anticipation of a revaluation of the yuan , which
was creating inflationary pressures on china.
• Finally china took a historic step on july 21, 2005
and pegging the yuan to a bigger basket .

• The basket is largely denominated by the dollar,

the euro, the yen and the won.

• The central bank of china in beijing also

introduced a central parity rate daily and then
allow a trading band.
Revaluation of the Chinese Yuan

Questions?
 Question 1
Evaluate the three choices that china faces in determining what to do with the
currency value . Which choice would you choose and why ?

Widening the trading band

• It is not appropriate for long run.
• In 2005 china had allow a trading band but the change was too small and U.S. and europe
continued to assert that the yuan was undervalued.

Pegging the yuan to a bigger basket

• china can pegs its currency to a larger basket of currencies .
• It would free the yuan from relying on the U.S. dollar
• also result in less volatility because some currencies
in the basket might be strong and others weak.
Letting the yuan float
• allow the yuan to float freely
• High risk is involved because there is no way of knowing how much the yuan will rise
against the dollar
• If it rises too far,too fast , it could choke off economic growth in china
• And it very difficult for an emerging market in china to handle the volatility .
How much is Yuan undervalued?

 Most economists believe that China should take a gradual

process in adjusting its exchange rate so as not to cause disruptive
effect on the economy in China and the that of the other countries.

 So I proposed a “two stage” currency reform:

 Stage 1:
• switch from a unitary peg to dollar to a currency basket
• a medium size (15 to 25 percent) revaluation of the Yuan
• widening of the currency band
 Stage 2:
a managed float system

In this category china allow it currency to float , but they also

intervene as necessary based on economic conditions .
Q2)On July 23rd 2005, China revalued the Yuan by
2.1%.Given that the exchange rate was 8.2725 prior to the
revaluartion, look at the exchange rate today.How much
hence the Uan revalued against the dollar sonce then?
Do you think this is enough to take th epresuure of China.
Why or why not.
In 1994 - $1 = 8.2725 Yuan
In 2011 - $1 = 6.8658 Yuan

Revalued by = 20.5 % (approx.)

Q3.Using table 10.1 ,which exchange rate
arrangement is China using now

• On July 21st 2005,China announced 2.1 % revaluation of

the Yuan-US dollar exchange rate and a change in its
exchange rate arrangement to allow the value of the Yuan
to fluctuate based on market supply and demand
• The establishment of the over the counter spot foreign
exchange market and the market for currency swaps and
futures
• From end july 2005-2006 the yuan exchange rate was
more flexible but the fluctuation in the yuan US dollar
exchange rate was less than 2%
 Ques-4
Assume that you are a Chinese exporter Would you
prefer a Chinese export tariff on selected garment and
textile exports as a way to relieve pressure against the
Yuan or a revaluation of the currency? Why?
 Textile exporter would prefer a revaluation of the currency. This is because
a broad devaluation would likely result in only little strengthening of the
Yuan while a targeted export tariff would result in a much greater loss of
competitiveness.

 Other type of Chinese exporter would prefer the textile export tariff. It
would have very little impact on business but would reduce political
pressure from foreign governments

 Chinese exporter would prefer the textile export tariff because the
revaluation would lead to increased capital inflows, which would bring
financial instability and would endanger china's financial security.

 Revaluation would facilitate imports of agricultural products, which would

be disastrous for China's more than 500 million farmers leading to more job
losses.
• Initially Chinese currency was at very much under value
compared to US.
• Their export value was very high as compared to import.
• US imposed pressure on Chinese government to revalue
their currency and get to the market level, and threatened
to pass steep tariffs on Chinese exports.
• China was forced to buy US currency and hence its foreign
reserve grew to a very big amount
• Further, they should continue to have US dollar as foreign
exchange ast it will appreciate the Yuan currency.