Development of the Exchange Rate in China

19 Feb

The evolution of the exchange rate in China over the last 30 years has been a process of development. Before 1994 China adopted an exchange rate strategy where it was a process of gradual devaluation of the currency towards the market rates. After this a fixed exchange rate regime was adopted with the currency being pegged to the US dollar. After 2005 the managing float regime was introduced whereby the exchange rate policy is based on a basket of world currencies which consists of countries that China have the most interaction with. In mid-2008, however, the RMB virtually returned to a dollar peg, by September 2008 all the weight once again had come fall on the US currency (J. Frankell, 2005, p.1). The regime had come full circle, virtually back to what it was in late 2005. The main reason for this change was down to complaints from exporter provinces which had lost competitiveness in 2007 as the currency appreciated against the dollar. This process of development has allowed China to experience superb economic growth and real presence and confidence on the world stage (Li. J, 2012). However, in recent years many countries like the United States believe that China have attempted to keep the Yuan artificially low to boost its exports. This tends to give the country an unfair trading advantage. Many authorities have pressured China to let the Yuan appreciate.

It is clear to see from China’s point of view that an undervalued rate will lead to domestically produced goods being relatively cheaper. This allows China to gain advantages in international competition. Another advantage of this undervalued exchange rate is that foreign investment becomes more attractive because the low exchange rate makes the costs of manufacturing low and exports become more profitable. An example of this in China is the Iphone manufacturer in Taiwan which is now on its way to becoming the sole supplier of Iphones.

The main reason why many countries especially the United States are pursuing in ensuring China allow the yuan to appreciate naturally is so that American firms do not find it as difficult to compete against the competitive prices of Chinese exports.

It is also important to note that even if China are benefitting hugely from the low exchange rate there are also drawbacks. The main point I will discuss is that of overheating the economy. The usual target for internal balance is usually defined as when output equals potential output. With an undervalued exchange rate exports are becoming increasingly popular therefore lead to an increase in demand which could lead us to the situation where output exceeds that of potential output. To alleviate this problem the Chinese government would have to either raise interest rate of undergo real appreciation. Both would have effects on unemployment and inflation. Therefore it is important to understand the consequences of valuing the exchange rate as effects may not always be favourable.

 

Moore, M. (2009). China exporters offer lower exchange rates to offset strong yuan. Available: http://www.telegraph.co.uk/finance/globalbusiness/4633944/China-exporters-offer-lower-exchange-rates-to-offset-strong-yuan.html. Last accessed 19th Feb 2010.

Liu, J. (2012). China loosens currency controls on the yuan. Available: http://www.bbc.co.uk/news/business-17721335. Last accessed 19th Feb 2014.Frankel, J. (2010).

The Renminbi Since 2005. The US-Sino Currency Dispute. 51-60 (1), p1.

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