Evaluate the US claim that China is manipulating its currency.
[A fixed exchange rate system is when the value of the exchange rate is fixed to another currency. This means that the government intervenes in the foreign exchange market to maintain the fixed rate.
A fixed exchange rate is compatible with free trade because the dollar price Chinese exporters charge for is the result of two things: the exchange rate and the cost in yuan for production. (Triple A reading)]
For the past years, China had a fixed exchange rate but recently managed to shift to the managed exchange currency rate. However, this change has brought about some frictions among some countries and China. US has recently been suffering from China and other countries’ current account surpluses. The US Treasury claimed that they had serious concerns about the rigidity of China’s exchange rate. According to the Chinese central bank, China’s foreign exchange reserves increased nearly 20% from a year ago to 2.27 trillion at the end of September. Some US lawmakers and industry groups claim that China keeps its currency intentionally on low levels against the dollar to gain advantages in trade.
China’s current account surplus with the U.S. this year may increase to $250 billion and some see this as China’s effort in trying to manipulating its currency, trying to destroy jobs and to limit growth in the U.S. However, it is true that China’s rate policies and the trade surplus is threatening the US. China’s effort in keeping the yuan undervalued leads to rising trade deficits, which will lead certain industries to increase pressure for protectionist US trade policies. Moreover, US concerns if they can continue to rely on China to buy US debt as US deficit grows because US will suffer if they lose the interest rates by China to finance their debt.
The graph above illustrates the increased supply of Yuan. The supply curve has shifted to the right and the price of Yuan in terms of U.S. dollars has decreased from P1 to P2 while the quantity has increased from Q to Q1.
Because Chinese yuan in undervalued, China had a current account surplus and so it is self-correcting the currency to depreciate. With weaker yuan, China would be able to export more to other countries but would decrease in imports. On the other hand, other countries such as US would have appreciating currency and suffer from trading with China. As a result, US export business will lose competition against China because China’s import goods are cheaper. However, if yuan’s exchange rate increases, the exports will decrease due to an increased price and the imports will decrease due to the decreased price.
All in all, China’s yuan is negatively impacting other countries. For the countries to earn back a “balanced” balance of payments, China should disregard its currency policy and let it self-correct on its own.
