For many years, the Chinese currency has been pegged to the U.S. dollar. Critics argue that this policy has resulted in an unfair advantage for Chinese manufacturers exporting product to the U.S., and has contributed to ballooning U.S.
Details:
Pressures for Change
- China fixed the value of its currency in 1994 to the US currency
- Due to arguments that the yuan was undervalued and that the Chinese government needed to free the currency, the U.S. administration announced that it would give the Chinese until October 2005 to revalue its currency
- Chinese government was forced to buy the dollars and issue yuan-denominated bonds as a way of “sterilizing” the currency
- China did not want to revalue under pressure from foreign government
- China has serious problems with employment
Yuan
- In July 21, 2005 China released the yuan to the U.S. dollar in favor of a currency basket, largely denominated by the dollar, the euro, the yen and the won
- The yuan is also influenced by the currencies of several other countries
- By the end of 2006 the yuan had appreciated by 5.68 percent since the peg to the US dollar was dropped in 2005
Necessary Institutions
- In June 2005, the State Administration of Foreign Exchange in China (SAFE) decided to allow banks in Shanghai to fixed rates trade and quote prices in eight currency pairs, including the dollar-sterling and euro-yen
- Prior to 2005, licensed banks were only allowed to trade the yuan against four currencies - he U.S. dollar, the Hong Kong dollar, the euro, and the yen
Options
- Widen the trading band against the U.S. Dollar
- Peg the yuan to a larger basket of currencies
- Allow the yuan to freely float
- Define the exchange rate.
- Briefly explain three types of exchange rate regime.
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