China's Fixed Exchange Rates Essay

1781 Words8 Pages
Fixed or pegged exchange rates are exchange rates that are held constant or allowed to vary within a very narrow margin (Madura 2008, p.154). The Chinese government re-instituted its Yuan peg during the global financial crisis in July 2008 after de-pegging in July 2005. The current USD/CNY and EUR/CNY rates of 6.52 and 9.46 respectively have been criticised as being too low, especially by the U.S. In fixing the exchange rates, central bank trades domestic and foreign exchange reserves to adjust the money supply such that the domestic interest rate equals the foreign interest rate. Since the Chinese’s foreign exchange reserves mainly compose only of US government and institutional bond, most of our analysis will relate more on the impact…show more content…
Those issues will be discussed later in the paper. The main benefit of maintaining a low fixed exchange rate for the Chinese economy comes from the low price of Chinese exports. This means that the demand for Chinese exports will increase, enhancing China’s trade surplus. Figure 1 shows that exports income accounts for almost 30% of the China’s GDP. This high dependency on exports of the Chinese economy is also the reason why the Yuan level is kept at a very low level. If the exchange rate is allowed to float, relative price of some Chinese-produced goods will increase and its competitiveness in the foreign market will decrease. As a result, exports will fall while domestic residents will start shifting for cheaper imports, resulting in a worsening current account. A study done by Lau et al. (2006) shows that 0.7 persons-year employments were generated for every U$1000 of aggregate exports. This shows that a fall in exports will cause a detrimental effect on Chinese employment level. An undervalued currency also increases China’s attractiveness, as a destination for foreign investments especially from the U.S. Foreign investment is a great way to promote technology transfers, which leads to economic development. Furthermore, tourism industry also boomed as overseas tourists find it cheaper to travel to China than other parts of the world. Fixing the exchange rate
Open Document