undervaluing the Yuan – catch 22

7 Mar

As controversy surrounding China’s undervaluing of its currency increases, the Senate Finance Committee in the US, in its semi-annual report, has said that Beijing did not meet the criteria to be called a currency manipulator. (If it had then it would have ben subject to trade sanctions from the US).

It claimed that there has been progress over this contentious issue with a 15% improvement in its valuation.

The Treasury claims that the Chinese authorities have reduced the level of intervention dramatically in exchange markets since the later part of 2011.

Since 2005 China has had a managed economy, pegged against a basket of foreign currencies. However, the US has claimed that China has taken steps in the right direction to liberalise controls on capital movements and thus eventually move towards a more flexible exchange rate.

Nevertheless, Chinese authorities have sought to use their competitive advantage in cheap exports to increase demand for Chinese goods after the economic crisis. However, there are many negative consequences of having an undervalued currency as well. Firstly most Chinese households’ buying power will be diminished and secondly there isn’t much pressure, via competition, for companies to develop more innovative products, which not only improve quality of life but also create many jobs.

Some Chinese economists have suggested that China could find better uses for the hundreds of billions of dollars it spends buying United States Treasuries and other foreign securities to keep the renminbi from rising against the dollar. This has an underlying tone of a threat towards the US, which may have been a reason why Obama recently stopped short of labeling China a currency manipulator, despite popular dismay internally at the very cheap currency.

This therefore highlights the catch 22 that the US and China appear to be caught in – The US needs to maintain a good relationship with China to preserve its money supply especially America’s debt, of which China is the largest foreign holder of. Similarly, China needs cooperation with the US due to its crucial market for Chinese goods – the US being China’s single largest exporting destination and thus plays a significant role in Chian’s economic growth and stability.

Consequently both sides are being cautious not to strain this dependent relationship. Thus the US doesn’t want to appear too harsh on China’s undervaluation whilst at the same time China realizes that it is attracting too much negative attention globally and thus needs to address this. But to what extent it will do this remains to be seen.

Sources: 

http://topics.nytimes.com/top/reference/timestopics/subjects/c/currency/yuan/index.html

http://www.financialexpress.com/news/despite-improvement-chinese-currency-still-undervalued-lew/1074117

http://www.bbc.co.uk/news/business-20518490

 

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One Response to “undervaluing the Yuan – catch 22”

  1. db7g09 March 12, 2013 at 6:10 pm #

    On the contrary, Lawrence Summers, the former top economic adviser to U.S. President Barack Obama, has said that China’s yuan is no longer as undervalued as it was five years ago. “The renminbi is not saliently, strikingly undervalued in the way it was five years ago,” Summers said in January at the Asian Financial Forum in Hong Kong. The comments are in line with tempered criticism from abroad of China’s control over its currency, even as the U.S. Treasury Department reiterated in November that the yuan “remains significantly undervalued.” The yuan has appreciated about 17 percent against the dollar since the end of 2007.

    China “has substantially reduced the level of official intervention in exchange markets since the third quarter of 2011,” the Treasury said in a statement accompanying its semi- annual currency report to Congress in November.

    However, the International Monetary Fund in July repeated an assessment that the yuan was “moderately” undervalued while omitting a previous estimate of the magnitude of the gap. China disputed the assessment and said the yuan was “now close to equilibrium or, at most, slightly undervalued,” according to an IMF report.

    U.S. Treasury Secretary Timothy F. Geithner said in May that further appreciation in the yuan is important to aid a reshaping of China’s economy as significant as the nation’s opening of its markets in the 1970s. Summers also said U.S. gross domestic product growth was probably about 1 percent last quarter. The median estimate of analysts surveyed this month by Bloomberg News was for an annualized rate of 1.5 percent.

    Crucially, if we are to agree that China is undervaluing the yuan, can it simply keep on devaluing its currency to achieve prosperity? Obviously no. Otherwise many small Third World nations would be rich by now, headed by Zambia. What determines the viability of a China to remain rich or become richer is how much the citizens can produce compared against how much the citizens will consume. If production exceeds consumption by a saving and reinvestment that spur greater production and followed by greater consumption but with the consumption growth not surpassing the production growth, then China can be sure to continue on a healthy economic growth. The currency only acts like the blood of a human body as the media of wealth transfer and hence the liquidity provider to such function.

    When the currency is overvalued, the economy will suffer because the extra wealth effect will activate a spending pattern which could not be sustained by the productive capacity of the citizens. On the other hand an undervalued currency will cost excessive liquidity which could not be sustained by the productive capacity of the citizens.Thus a faulty adjustment on the value of the currency will either cause an excessive spending pattern which will cause a long term bankruptcy or an excessive liquidity which will cause an immediate inflationary pressure that may spin the economy into an uncontrollable death.

    So there is no need to speculate whether a currency is undervalued or not? While over valuation will take a longer term to manifest in near bankruptcy, under valuation could immediately manifest in the form of inflationary pressure that will kill the economy if some reversal policies are not taken. Therefore a currency is not undervalued if there is no inflation which is threatening the economy.

    Eleni Himaras ‘Summers Says Yuan Isn’t as Undervalued as It Was Five Years Ago’ http://www.bloomberg.com/news/2013-01-14/summers-says-yuan-isn-t-as-undervalued-as-it-was-five-years-ago.html – 14 January 2013 – [accessed 12/03/2013].

    Ian Talley ‘IMF Reviewing Whether Yuan Still ‘Substantially’ Undervalued’http://online.wsj.com/article/SB10001424052970204573704577187670284231172.html – 27 January 2012 – [accessed 12/03/2013].

    Dilip K. Das ‘The evolution of renminbi yuan and the protracted debate on its undervaluation: An integrated review’ (2009) Journal of Asian Economics, Volume 20, Issue 5, (2009) 570–579.

    Anthony J. Makin ‘The Inflexible Yuan and Global Imbalances’ (2008) Global Economy Journal
    Volume 8, Issue 3, 1-10.

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