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Devaluation renminbi

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Dinesh Pupala

This document discusses several topics related to China's currency (renminbi) and exchange rates: 1) It outlines different arguments from the US and China regarding China's devaluation of the renminbi, with the US citing its large trade deficit and China saying the move pegged the currency to a basket of currencies. 2) It explains that countries like Japan, South Korea, and others in Asia are less vocal than the US in criticizing China's currency valuation because they have strong economic ties to China and benefit from processing trade. 3) Finally, it discusses the potential consequences of China revaluing its currency higher, including reduced Chinese exports and improved trade balances and GDP for countries like the US

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China’s devaluation of renminbi Macro Economics
 US Arguments  huge trade deficit of US$233 billion  threatened to impose a 27.5% tariff  China Arguments  it was done to peg to basket of currency  US should improve its economy Different arguments used by the U.S. and Chinese governments about the renminbi.
 They have strong economic links with china  Many company of these countries have moved there production units to china keeping only high value components production at home  The above countries capture most of the benefits by processing trade with china  china imports the raw materials/intermediate goods from these countries then processes and re-exports them Why are Japan, the newly industrialized economies (NIEs) and developing Asian-Countries less vocal than the US on the valuation of the renminbi?
 Volatility in the exchange rate exerts a powerful impact on exports, imports and the trade balance  It affects level of development of the country through its effects on foreign direct investment inflows  Depreciation in exchange rate gives rise to inflationary pressures; imported good become more expensive both to the direct consumer and to domestic producer How does the exchange rate of a currency and its volatility have a direct impact on the economy?
 Exchange rate of a currency is determined by various ways:-  Floating exchange rate:-In this case exchange rate of a currency is allowed to fluctuate with the dynamics of the market.  Fixed/Pegged exchange rate:-Here the currency of a country is fixed or pegged with currency of other currency  Currency Pair:- In this scenario one currency is dependent on another currency in foreign exchange market How is the exchange rate of a currency determined?
 Current Account:-China had a huge current account surplus because of its export earnings  Capital Account:-  Direct Investment flows-It is Positive and shows continuous increase from 2002 to 2006  Portfolio Investment flows-It is negative  International reserves:-  Chinese government had huge increment in international reserves Analyze the different components of the Chinese balance of payment.
 It held the value of renminbi at constant rate of RMB 8.28 over a decade  china has passed legislations by which it restricts the amount of foreign currency in the state  On a daily basis each bank has to maintain the specified ratio of foreign currency Do you think the renminbi is undervalued against the US dollar? How can China Maintain the exchange rate of the renminbi?
 To make its exports more competitive in the global markets  To encourage Chinese products in the global markets and promoting various industries to set up low cost production units in china  This helped china to become world’s third largest exporter with an estimated US $970 billion for the year 2006 Why does the Chinese government want to keep its currency at an artificially low level Against the US dollar?
 Sterilized intervention:-Central bank absorbs all the extra renminbi by selling bank/government bonds  Interest Rates:-By increasing the interest rate of the central bank  Reserve Ratio:-By increasing the reserve ratio of central bank Exchanging all of China’s US dollars for renminbi can lead to inflationary pressure. How does China avoid this risk?
 It costs china in terms of inflation due to more money supply  It fixed the foreign reserve ratio  Policy regarding buying of US treasury bills Does maintaining a quasi-peg to the US dollar have a cost for China? Does the policy of buying US Treasury bonds have any negative impact on China’s or the world’s Economy?
 Chinese export will become costly and demand for Chinese product will goes down  For US and European countries, their trade deficit with china would reduce, GDP improves  neighboring countries like Japan, Korea would be affected as they outsource their most of processing work in China  Other Asian countries which makes same kind of products would get some chance to compete with China What would be the consequences of a revaluation for China, western countries, Japan, NIEs and developing countries?

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Devaluation renminbi

  • 2.  US Arguments  huge trade deficit of US$233 billion  threatened to impose a 27.5% tariff  China Arguments  it was done to peg to basket of currency  US should improve its economy Different arguments used by the U.S. and Chinese governments about the renminbi.
  • 3.  They have strong economic links with china  Many company of these countries have moved there production units to china keeping only high value components production at home  The above countries capture most of the benefits by processing trade with china  china imports the raw materials/intermediate goods from these countries then processes and re-exports them Why are Japan, the newly industrialized economies (NIEs) and developing Asian-Countries less vocal than the US on the valuation of the renminbi?
  • 4.  Volatility in the exchange rate exerts a powerful impact on exports, imports and the trade balance  It affects level of development of the country through its effects on foreign direct investment inflows  Depreciation in exchange rate gives rise to inflationary pressures; imported good become more expensive both to the direct consumer and to domestic producer How does the exchange rate of a currency and its volatility have a direct impact on the economy?
  • 5.  Exchange rate of a currency is determined by various ways:-  Floating exchange rate:-In this case exchange rate of a currency is allowed to fluctuate with the dynamics of the market.  Fixed/Pegged exchange rate:-Here the currency of a country is fixed or pegged with currency of other currency  Currency Pair:- In this scenario one currency is dependent on another currency in foreign exchange market How is the exchange rate of a currency determined?
  • 6.  Current Account:-China had a huge current account surplus because of its export earnings  Capital Account:-  Direct Investment flows-It is Positive and shows continuous increase from 2002 to 2006  Portfolio Investment flows-It is negative  International reserves:-  Chinese government had huge increment in international reserves Analyze the different components of the Chinese balance of payment.
  • 7.  It held the value of renminbi at constant rate of RMB 8.28 over a decade  china has passed legislations by which it restricts the amount of foreign currency in the state  On a daily basis each bank has to maintain the specified ratio of foreign currency Do you think the renminbi is undervalued against the US dollar? How can China Maintain the exchange rate of the renminbi?
  • 8.  To make its exports more competitive in the global markets  To encourage Chinese products in the global markets and promoting various industries to set up low cost production units in china  This helped china to become world’s third largest exporter with an estimated US $970 billion for the year 2006 Why does the Chinese government want to keep its currency at an artificially low level Against the US dollar?
  • 9.  Sterilized intervention:-Central bank absorbs all the extra renminbi by selling bank/government bonds  Interest Rates:-By increasing the interest rate of the central bank  Reserve Ratio:-By increasing the reserve ratio of central bank Exchanging all of China’s US dollars for renminbi can lead to inflationary pressure. How does China avoid this risk?
  • 10.  It costs china in terms of inflation due to more money supply  It fixed the foreign reserve ratio  Policy regarding buying of US treasury bills Does maintaining a quasi-peg to the US dollar have a cost for China? Does the policy of buying US Treasury bonds have any negative impact on China’s or the world’s Economy?
  • 11.  Chinese export will become costly and demand for Chinese product will goes down  For US and European countries, their trade deficit with china would reduce, GDP improves  neighboring countries like Japan, Korea would be affected as they outsource their most of processing work in China  Other Asian countries which makes same kind of products would get some chance to compete with China What would be the consequences of a revaluation for China, western countries, Japan, NIEs and developing countries?