Is China really pegging the Yuan to the American Dollar?
China is taking over the economic world and a large number of people attribute China’s progress to their infamous policy of pegging the Chinese Yuan to the American Dollar. This is however incorrect. As of July ’05, the Chinese administration allow day-to-day changes of upto 0.3%. What does that mean? It is not really pegged to the US Dollar, but it is still strictly regulated. Upon closer inspection, we can see that the Chinese Yuan traded at a static 8.2765 CNY until June ’05 compared to the 6.34811 CNY value for each USD as of Dec ’11. That is a 23.3% appreciation in the value of the CNY. In spite of this, it is believed that the Chinese Yuan is still undervalued by about 40%.
Why would a nation undervalue it’s currency?
An undervalued currency means the the country can sell products at a much lower price overseas thereby increasing exports. This is espcially important for countries such as China that is heavily dependant upon exports for economic growth as well as creates a large number of jobs for its ever increasing population. Undervaluing the currency however increases commodity prices thereby contributing to inflation. It is thus a tight rope act for the country to decide how long to undervalue their currency and when to allow free market economics decide the value of the currency.
Whats the deal with the Euro crisis?
The problem is that a whole bunch of countries in Europe have taken on such a large amount of loans that the banks are now extremely wary of loaning them any more money. Further to make things worse, a lot of the money owed has been lent by the banks of the “stronger” countries of the EU (which is really just France and Germany). This is bad because if these “weak” countries were to default, these banks would be in trouble which would in turn also push the strong countries into a troubled setting. NYTimes came out with a wonderful infographic that traced debt in the EU region.
But how does currency undervaluation fit into the Euro crisis?
Washington Post explains the Europe debt crisis much better than I ever could. But also buried in the same article is a very insightful comment that I thought I should pull out here:
Germany has had, in certain ways, a very good, and very unusual, decade. Unlike almost every other advanced economy on Earth, it has seen its manufacturing sector boom. Typically, as a developed country becomes more productive and its exports become more popular, its currency appreciates, which makes its exports more expensive, and less popular. Conversely, when weaker countries see their economies fall apart, their currency depreciates, and that makes their exports cheaper and helps them recover.
But Germany’s currency hasn’t appreciated very much, because it’s tied to the euro, which is dragged down by the weak economies in southern Europe. And the southern European countries haven’t seen their currency depreciate very much, because they’re tied to the euro, which is propped up by stronger economies like Germany. The net result has been a big, artificial boost for Germany’s export sector, and a big obstacle to recover for much of the rest of Europe.
In conclusion I am still not sure, how a country makes an objective decision as to when and by how much the currency should be undervalued. If someone can point me to a rational and objective reasoning about this, I’d be much indebted.