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Chinese Yuan and flexibility
Chinese authorities announced plans on Saturday to make the exchange rate more flexible, while ruling out a large, one-off move in the Yuan’s value. China’s central bank says it plans to keep the Chinese Yuan “stable” and there will be no immediate revaluation of the currency says the BBC.
Stock markets from New York to London to Hong Kong reacted positively to the announcement.
Currencies were also up, with the Korean won and Malaysian ringgit both rising over 2% against the US dollar.
Background
China does not allow its currency to float but rather pegs the Yuan to the dollar which depreciates its value so that Chinese goods are cheaper and knocks out competitors on the international market. This has worked well for China’s export driven economy. China saves a lot so that the investment from savings primarily goes to support manufacturing and export while the remainder (savings) is exported to the US.
The US has consistently accused the Chinese of cheating and exacerbating the imbalances that has fed the global credit crunch. The US economy is driven by the consumption component of gross domestic product (GDP) while the Chinese economy is driven by the export component. High consumption in the US has fed Chinese exports and savings
Every country needs to consume, save/invest, export and import according to her resources as dictated by markets. China has not been consuming enough and the US has not been saving. This imbalance has fed the global recession.
The demise of the US consumer will hurt China in the short run. While the US, UK amongst others need to save more so they can be more productive and increase exports. Greater export is crucial for the US and Western Europe to escape their debt trap.
Global Expectations
What a flexible Chinese currency is expected to achieve is alter this export driven model. A flexible currency is expected to push up the value of the Yuan which will increase the price of Chinese goods abroad and reduce exports. This also means that the Chinese will have to save less and consume more. The expectation of the US and Europe is that a flexible Yuan will increase the price for Chinese goods – If China sells less the US sells more!
Short run implications
Allowing some flexibility for the Yuan might not cause it to appreciate but depreciate. This is because Chinese exports markets in Europe and the US is in a recession. Lack of demand will reduce investment in China and eventually exports. A reduction in exports will hurt the Chinese economy because it is primarily export driven so that the eventual outcome is a depreciation of the Yuan. A depreciation for the Yuan means that China will continue to out sell the US and other competitors (they are more productive anyways) even in this downturn
Long run implications
In the long run as China consumes more and saves less their economy will benefit from increased productivity and Beijing will allow the Yuan to appreciate a lot more as a result. Market forces will reallocate excess savings into more production to serve growing demand in China and elsewhere. This is a more efficient use of Chinese savings and will grow the Chinese and global economy, instead of the inefficient way (buying US debt) it has been utilized which has had a negative effect on the global economy.
Conclusion
In the short run, its more bad news for Washington and Brussels - a flexible Yuan will not boost US exports but hurt it.
Pressuring the Chinese to allow flexibility for the Yuan will only help China become the biggest economy in the world sooner than later
Chinese Yuan and flexibility
Chinese authorities announced plans on Saturday to make the exchange rate more flexible, while ruling out a large, one-off move in the Yuan’s value. China’s central bank says it plans to keep the Chinese Yuan “stable” and there will be no immediate revaluation of the currency says the BBC.
Stock markets from New York to London to Hong Kong reacted positively to the announcement.
Currencies were also up, with the Korean won and Malaysian ringgit both rising over 2% against the US dollar.
Background
China does not allow its currency to float but rather pegs the Yuan to the dollar which depreciates its value so that Chinese goods are cheaper and knocks out competitors on the international market. This has worked well for China’s export driven economy. China saves a lot so that the investment from savings primarily goes to support manufacturing and export while the remainder (savings) is exported to the US.
The US has consistently accused the Chinese of cheating and exacerbating the imbalances that has fed the global credit crunch. The US economy is driven by the consumption component of gross domestic product (GDP) while the Chinese economy is driven by the export component. High consumption in the US has fed Chinese exports and savings
Every country needs to consume, save/invest, export and import according to her resources as dictated by markets. China has not been consuming enough and the US has not been saving. This imbalance has fed the global recession.
The demise of the US consumer will hurt China in the short run. While the US, UK amongst others need to save more so they can be more productive and increase exports. Greater export is crucial for the US and Western Europe to escape their debt trap.
Global Expectations
What a flexible Chinese currency is expected to achieve is alter this export driven model. A flexible currency is expected to push up the value of the Yuan which will increase the price of Chinese goods abroad and reduce exports. This also means that the Chinese will have to save less and consume more. The expectation of the US and Europe is that a flexible Yuan will increase the price for Chinese goods – If China sells less the US sells more!
Short run implications
Allowing some flexibility for the Yuan might not cause it to appreciate but depreciate. This is because Chinese exports markets in Europe and the US is in a recession. Lack of demand will reduce investment in China and eventually exports. A reduction in exports will hurt the Chinese economy because it is primarily export driven so that the eventual outcome is a depreciation of the Yuan. A depreciation for the Yuan means that China will continue to out sell the US and other competitors (they are more productive anyways) even in this downturn
Long run implications
In the long run as China consumes more and saves less their economy will benefit from increased productivity and Beijing will allow the Yuan to appreciate a lot more as a result. Market forces will reallocate excess savings into more production to serve growing demand in China and elsewhere. This is a more efficient use of Chinese savings and will grow the Chinese and global economy, instead of the inefficient way (buying US debt) it has been utilized which has had a negative effect on the global economy.
Conclusion
In the short run, its more bad news for Washington and Brussels - a flexible Yuan will not boost US exports but hurt it.
Pressuring the Chinese to allow flexibility for the Yuan will only help China become the biggest economy in the world sooner than later
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