Tuesday, May 22, 2007

Should the Chinese Revalue their Currency (Renminbi)?

Evaluate the impact of a sustained rise in the value of the Chinese Currency (Renminbi) against the dollar?

If The value of the Chinese currency increases, it will mean it is cheaper for Chinese consumers to import from abroad. It will make Chinese exports relatively more expensive.

The US currency will be weaker and therefore it will be more expensive for American consumers to buy imports from China.

Therefore this may lead to a reduction in the Chinese current account surplus and a reduction in the US current account deficit. This is because Chinese exports become less competitive and so will import less from China.

However, it depends upon the elasticity of demand for imports and exports. For example, if US demand for Chinese exports is inelastic, then an increased price of exports will not reduce their value. Also, the US may simply switch to buying these imports from related Asian economies.

Benefits of an Appreciation in the Chinese Currency

1. Improvement in current account deficit
China's trade surplus with America was $233 billion in 2006, this is almost 30% of America's total deficit. However, the improvement in the deficit may be much smaller than anticipated. A revaluation will not tackle underlying problems of low US savings and changing comparative advantage

2. Help Reduce Chinese Inflation.
Higher exchange rate will help reduce inflationary pressures in China for 3 reasons;
  • Lower AD falling Exports (Exports is a big component of Chinese AD)
  • Price of Imported goods is cheaper.
  • Chinese exporters have greater incentive to cut costs and increase efficiency. This can benefit the economy in the long run.

this is important, because the Chinese economy is growing above 10% per annum. (11.1%) most recent. There are concerns this could lead to inflationary pressures. An appreciation will help to moderate growth; in particular reduce the investment and borrowing boom, which results from low interest rates

3. Help economic growth and reduce unemployment in US.

It is argued that many American exporters are losing out to Chinese firms. If the Chinese Renminbi was revalued, it would allow an increase in demand for US good. This could be important with American growth slowing. However, American politicians exaggerate the impact of a low Chinese currency on the US economy. Firstly, US unemployment is quite low at 4.5% and the US trade deficit is merely a reflection of the low US savings ratio (and high consumer spending) if the deficit wasn't with China it would be with somebody else.

Problems of an appreciation

1. Could lead to lower economic growth in China

An appreciation will reduce economic growth, this could exacerbate the problem of unemployment resulting from privatisation. This is the main reason the Chinese government is reluctant to revalue. However, with growth of 10%, maybe they do not have the right priorities. Even though Exports are the main determinant of growth, an appreciation is unlikely to cause any serious damage to economic growth. A slightly lower growth rate would have several advantages, primarily low inflation.

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