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china currency peg


sherlyn chen

on 23 February 2010

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Transcript of china currency peg

Group 3 Chen Yilin Sherlyn
Ng Tee Lim
Shen Yang China Currency Peg From 1994 until July 2005, China maintained a policy of pegging the RMB to the U.S. dollar at an exchange rate of roughly 8.28 yuan to the dollar
Revaluation of the Reminbi in July 2005
Was said to involve a shift away from the fixed exchange rate, a gradual movement towards greater flexibility and a peg to a basket of currencies.
After allowing the yuan to rise for much of 2007 and 2008, authorities repegged it to the dollar in mid-2008. Background on the China currency peg Rest of the world China USA Which firms/industries gain/lose due to the peg?

An undervalued RMB increases the purchasing power of US producers -> import cheaper capital equipment and inputs to final products from China -> increasing competitiveness of these firms Gain Loss U.S. exports and the production of U.S. goods and services that compete with Chinese imports fall, in the short run (manufacturing and other labour intensive sectors) Gain/loss on government/consumer in US and China due to the peg China USA By investing in US assets, the Chinese allows for more capital investment in plant and equipment than it would occur - downward pressure on interest rates, US firms are more willing to accept unprofitable investments -> US economic expansion in long run China is the largest holder of US treasury securities as of Sept 2009 - if China sells its US reserves, US government will have to find ways to finance its budget deficit; increase government's interest payments

U.S. consumers have gained from the supply of low-cost Chinese goods (which helps to control inflation) The Chinese goverment wants to protect the value of China investments on US securities- appreciating the RMB will cause losses in US related assets
Workers unrest - should RMB appreciate there will be loss of jobs in export-intensive industries
Economic growth will decline in the short run as exports become more expensive and FDI decreases By removing the peg to the USD and slowly appreciating the RMB, China can rebalance its economy by being less reliant on exports and fixed investment in the long run.
Money freed up by investing less in US securities can be used to promote domestic consumption, improve the social safety net and boost living standards among the poor.
Revaluing the RMB and moving away from the peg can help contain inflation If RMB appreciates, employment rate in USA will increase in the short run Conclusion: to peg or not to peg? Depending on which parties interest we are trying to safeguard By unpegging the Yuan to the dollar:
will have both positive and negative impacts on all parties
need to weigh the significance of the impact to each affected parties

Short Run... China will take a bigger hit relative to that of US in the short run when Yuan appreciate

Reduction in US trade deficit, but not significant. Remove China’s support in buying out the treasuries, US will have to cut down its lending and spending. Higher cost of borrowing will lead to reduction in consumption and investment, slowing down economic growth

The benefits will spill over to the rest of the world that will try to correct the global imbalances, in particular the developing nations. Imports from other countries will fill up the space

Not advisable to major financial decision in this times of financial uncertainty
Long Run... After the global recession has stabilized, it is more suitable to implement such a major decision

Cut down the reliance on both parties to sacrifice its short term interests and focus on more long term approach
US want China to buy out its treasuries
China achieving high (sustainable?) growth rate

Forces both government to pursue more realistic policies:
US to rely on non credit or asset bubbles that are highly reliance on over-borrowing.
China to reduce its reliance on its export-oriented economy and direct its resource inwards to develop its domestic capabilities
Solution Gradual movement away from the peg through progressive stages so as not to generate global panic in the financial market.
Allow for follow up policies to dampen the impact before fully implementing the system.
Adopt a flexible exchange rate system that adjust accordingly.
China as the new reserve currency? Background China proposed to replace US as the international reserve currency with a new global system under IMF

Based on historical data, it is inevitable that China will replace US as a reserve currency, just like how US replace the Britain Pound.
UK biggest debtor, US biggest creditor
US biggest debtor, China biggest creditor
Current situation Unlikely in the near future

Restrictions in the money entering and leaving China
China currency is not fully convertible at the moment
Need to make its bond market more liquid
Financial institutions are not well developed enough However.. China is taking steps:
Set up currency swaps with several countries (Argentina, Malaysia, Indonesia)
Allow Hong Kong to distribute bonds
Using Yuan to trade instead of the usual US dollar (Brazil)

Exporting firm Vs. Non-exporting firm

China's policy has resulted in a large depreciation of the yuan against the euro, making it extremely hard for European firms to compete with Chinese ones.

China’s currency policy induces other East Asian economies to intervene in currency markets in order to keep their currencies weak against the dollar in order to compete with Chinese goods.
Gain Loss Gain Loss Gain Export-driven industries like the manufacturing and textile sector have benfitted from the increase in exports from an undervalued RMB. Loss Firms that rely heavily on imports are adversely affected from an undervalued RMB Q&A
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