Monday, October 18, 2010

The Chinese Currency Debate

At this point in the global economic cycle, many countries are seeking a more competitive exchange rate. However, when all countries want a weaker exchange rate, it becomes difficult to please everyone.

Most focus has centred on the value of the dollar / Yuan. The IMF state (link) that the Chinese Yuan is undervalued compared to the US dollar. Economists such as Paul Krugman, argue that this undervaluation of the Yuan means a loss of jobs and output in the US.

If China stopped buying so many US Treasuries, the dollar would weaken making US exports more competitive and help the stagnant recovery. However, China is resisting pressure to allow Yuan to appreciate because it is following a policy of boosting exports and growth.

It can be argued this policy of a weak Yuan is in danger of overheating the Chinese economy. The strong demand for exports is encouraging speculative investment. Also, the unsterilized foreign currency holdings (link) and strong export demand are in danger of boosting Chinese inflation.

However, on the other hand, the US consumer is benefiting from cheaper Chinese goods which is increasing their living standards. This increases their disposable income to spend on other goods.

China's intervention has led to foreign currency reserves of $2.6 trillion - the highest in the world. This accumulation of foreign currency reserves is a mirror of the recurring Chinese current account surplus.

The irony is that China has been one of the best buyers of US Treasuries helping to finance the US deficit. The other irony is that China holds so many dollar assets it has a vested interest in the value of the dollar. Tentatively it has started to diversify (such as buying Yen this year). However, the Chinese Yuan is only pegged against the US dollar. Whilst they maintain this dollar peg, there will always be a need to buy dollar assets.

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2 comments:

Fatuberlihu said...

China's currency reserve: $2.6 billion or 2.6 trillion?

Basudeb Sen said...

That undervalued yuan relative to US$ is adversely affecting the US output and employment is far from the Truth. China exports mostly those goods to the US that the US found it uneconomic to produce in the US given the US wage rates. Rather, the undervalued Yuan is hurting other third world countries exports to the US. Chinese government through its pegging of Yuan/dollar rate is hurting its own national interest just to keep the country's exploited labour find some employment: the costs to China are low wages to Chinese labour, low earnings on its holding of US treasury bill assets, risk of losing the value of these assets when the Chinese ultimately tries to use these dollar assets to buy some thing from countries other than the US. It is unfortunate that Marxian, Leninist and Maovian Economic theory do not have any prescription for the Chinese to get out of their export to US-dependency for protecting output and employment. They have no option but to let US capitalists and consumers appropriate the better part of the surplus value produced by the Chinese labour. Sooner or later, China and the US have to get out of this basic imbalance.