China: to Float or Not to Float

1925 Words Jan 20th, 2013 8 Pages
China: To Float or Not To Float?
International Finance

1 - What are the implications of China’s exchange rate policy on doing business with and “against” China?

For years, China’s currency was undervalued. Many analysts and economists estimated that the Chinese currency (Yuan) was undervalued by 35%. So, for years, China kept a higher exchange rate.
By doing so, China has some advantages but also some disadvantages.
First, by undervaluing its currency, China keeps the Yuan as a weak currency, (because you need more Yuan to buy a US dollar). By doing that, China was able to keep a competitive advantage over other countries such as the US. Their products were sold for a cheaper price compared to the US products.
But even if there
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China's economy is largely based on the exportation of consumer goods. A cheap Yuan keeps prices low and, so far, the economy is flourishing.
China keeps its currency devalued against the dollar which allows the country to raise its exportation over its importation and then increase its reserves of foreign currencies.
Members of the U.S Congress accused China of illegally manipulating its exchange rate and countries put pressure on China to revalue its currency and institute more flexibility.
But what would changes in exchange rate policy impact growth in China as well as the rest of the world?
• If China appreciates its Yuan:
Robert Mundell, Nobel Peace Prize winning economist from Columbia University thinks that appreciating the Yuan would be a mistake. “It would cause deflation, cut economic growth, cut off foreign direct investment …”
Indeed, Chinese citizens will see their purchasing power increase but china will loose its competitive advantage in term of trades.
Factories will move to countries with cheaper labour. This could provide opportunities in export for emerging markets but would have a negative impact on companies in China that are dependent on the advantages provided to them by a cheap renminbi.
The United-States think that an appreciation of the money would increase their exportation and solve their unemployment issues, accusing China to “undercut American workers” with low-cost labour; and yet job losses in the US are