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In the recent past and even at the present time there have been expressions of concern especially from the United States and other world economies that the yuan has been seriously undervalued. The value of the Chinese yuan has brought on board many debates and pressure has been heaped on the government of China. Grievances have been aired claiming that the currency is undervalued by as much as 40 percent. It has been claimed that such undervaluing of the yuan has placed the nation of China in an advantageous position against other global economies and particularly the US. It has also been noted that this practice has led to the damage of the manufacturing sector in the US. In reaction the Chinese officials claim that their pegging of the yuan to the dollar is not meant for unfair trade advantages but for economic stability of the country. The Chinese officials claim that if the yuan is to be left to fluctuate at the market values then this will result to serious dislocation in the domestic economy of China. From this point of view the issue of the yuan being pegged to the American dollar and what should be done to alleviate the negative effects which arise from this practice becomes a complex issue. Although there were attempts by the China government to allow the yuan to appreciate freely at the market rates it could not satisfy the required changes that were desired. This was because a crawling peg was introduced. This made it impossible for the yuan to rise gradually in its value. There have been persuasion pressures from various quarters for China to adopt mechanism which can allow the yuen to rise in its value. In reference to this introduction this paper makes an attempt to investigate and analyse how valid is the criticism of the Chinese Government keeping their currency low. Relevant arguments are brought to surface with facts being analysed in the attempt to determine whether it is true that yuen has intentionally being kept low.
China is undisputedly one of the fastest growing economies in the world. This has been due to largely mass changes which the country undertook from being a dictatorial and communist nation to venture into the world of capitalism. It has been claimed the when the country was under the leadership of Mao everything was controlled with the economy and the business population being stable. With the entry of another great leader, Deng Xiaoping, in the late 70s China was opened up to the rest of the world. This was done by private businesses being allowed into China thus changing the aspect of economics in China. This led to the conversion of the country into a free market country and thus leading to free exchange of goods with various countries. The country was in a free market and that meant the prices were responsible for the rationing of the goods and services. All the production activities are also entitled to the private hands with the market forces (1) being left to determine the wages and the prices of goods and services in the economy.
The nation of China has the advantage of possessing a huge population. This population presents readily available and cheap labour which is used in carrying out the production process. Cheap and readily available labour makes it possible for the production process to be carried out cheaply resulting to the production of goods in mass numbers which can be sold at low prices. This factor has made the country to produce low cost goods which are exported to various economies in the world. Actually china is one of the economies with the largest exports with its exports finding ways to many economies around the world. The cheap exports from china have benefited many nations as well as causing damaging effects to many other nations. It has been argued that the cheap exports of China have not just resulted from the cheap labour fact but due to pegging of the yuen on the dollar. This has been said to have significant effect on the price of the Chinese exports making them extremely cheap and thus attaining a competitive edge at the world market. The cheap Chinese goods have raised eyebrows especially from countries which are negatively affected. This has led to the nation being silently being viewed as a currency manipulator. There have been bitter claims that the Chinese government has taken intentional steps to keep its currency low so that it gains in the international market. It is claimed that with the low yuen currency it becomes possible for the government of China to subsidize its exports. It has been argued that the exports from China have undercut manufactures from other countries particularly from the USA. The situation has also made it rough for manufacturers from France and Germany who are able to compete head on head with the manufacturer from China thus pushing them out of the market and increasing the demand for the Chinese goods.
How government fixes value of currency
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From the 1990s the central bank of China had the Yuan currency fixed at eight per one US dollar. this was precisely accomplished between the 1990 to 2005. It has been noted that this exchange rate is fixed above the free market rate implying that if the currency is left freely to float at the free market it will rise substantially. The tying of the Yuan to the US dollar has caused the falling of the US dollars in relation to other currencies since 2009. Although China is involved in free trade the act of keeping its currency low has made it possible for the exports of the country to be highly demanded while at the same time less volume is being imported. It has been argued the undervaluing of the Yuan in reference to the dollar has made it a big hindrance for the US exports to China. It is also claimed this has given Chinese products an upper hand in terms of prices. According to Ferrington (2006), "China's currency is held by government action at a level well below its true value and that, without official manipulation, the value of the Yuan would rise substantially" (p. 45). Ferrington (2006) argued further that the effect of this undervaluing is seen in the trade deficits experienced by the US in terms of trade deficits and the harm which has been caused to the manufacturing industry. Before engaging into any further discussion of whether China is engaging in currency manipulation or not, first let us discuss what actually entails currency manipulation.
Currency manipulation has been viewed as a difficult and complex issue. Up to the 1970s the IMF was crucial on the issues of the world exchange rates. All the currencies by then had a value which was fixed in relation to the US dollar. The US dollar had a fixed value in relation to gold. The IMF had to approve the changing of the par value of a currency before such a change could be implemented. However, since 1976 with the passage of the second amendment to the IMF articles of agreements changing of the exchange rates became a dispensation of individual countries. Since then countries have floated the value of their currencies in the world trade market while others have fixed the value of the currencies to the other currencies with still others pursuing a mixed strategy (Ferrington 46).
It should be noted that however that the IMF still undertakes some surveillance exercise on countries in relation to the value of their currencies. This is made possible through the Article IV of the IMF Charter which entitles IMF to ensure that individual countries do not get involved in fixing of the currency value with the aim of benefiting themselves in terms of trade. In essence countries are allowed to influence the value of their currencies but with paying some attention to some basic factors; "countries may peg the value of their currency to another currency but they cannot do this in ways which violate the requirements of article IV" (Ferrington 46). To best discuss this le us quote article IV of IMF; this article is an agreement of countries and reads that countries shall "avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payment adjustment or to gain an unfair competitive advantage over other members" (Ferrington 44). This same article also empowers the IMF to take some measures against a member country which goes against the agreement in the article.
The above discussion brings into light that the action of pegging a member currency to another member currency is allowed as long as some basic conditions are adhered to. If we go back to our context then that implies that China is not illegally tagging the yuan to the US dollar then the question to be answered is not whether the Chinese officials are manipulating their currency but rather whether they are doing that within the allowance given by the IMF. In other words it should be determined whether the Chinese officials are adhering to the basic standards set by the IMF in regard to pegging of a currency. Ferrington (2006) argues that the principle focus in staying in line with the basic condition when pegging a currency to another currency is the need to ensure that the pegged rate gives a reflection of a country's underlying economical realities. It can be rightfully argued that the IMF allows manipulation of a currency to minimum levels with an aim of correcting some anomalies but if such a practice persists and if it is aimed at different aims such as unfairly gaining trade advantages over other members then such a practice becomes officially manipulation of a currency. With such a definition it becomes a bit hard to determine whether China is engaging itself in currency manipulation or it is just doing an activity that is allowed by the IMF. And if the later is true is it engaging in the act within the allowed limits? The IMF has put it clear when a country ought to involve other member country when pegging its currency to the member currency, "when there is protracted large scale intervention in one direction in the exchange market; behaviour of the exchange rate that appears to be unrelated to underlying economical and financial conditions including affecting competitiveness and long term capital movements" (Ferrington 46). This criteria will be revisited below after some factors and facts are examined in relation to the trading of China particularly its exports and imports.
More often than not Chinese officials have argued that the country has pegged the yuan to the dollar for the purpose of protecting its domestic economy. It should be the IMF allows this. Under the IMF directions countries are allowed to use their exchange rates for the purposes of promoting growth and development. But it should be noted that there are conditions which need to be fulfilled. Basically as much as countries are allowed to take care of their own economies they are also called upon to ensure that the interest of other countries is not affected. The adjustments include things as accumulation of excess reserves, capital inflows or outflows to fund or offset BOP deficit or surpluses respectively. It has been noted that if a country fails to adjust its BOP balance then the burden of adjusting is thrown over to the trading partners. This is felt by the trading partners through such means as unemployment, monetary contraction and such like things (Ferrington 46).
China and Manipulation
Chinese officials have persistently claimed that the pegging of the yuan to the US dollar is purely for the domestic stability of the nation of China. It is claimed by the Chinese officials that if the yuan left rise it will hurt the domestic economy of the country of China. However the most important question to ask is whether this practice of attaining internal economy stability is throwing undue burden on other nations and thus violating the allowance by the IMF to peg currencies for purposes of stability.
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It has been shown that countries seeking to stabilize their economies through sustaining unrealistic exchange rates often discover that the foreign exchange reserve they hold is insufficient for the maintenance of the exchange rate at the desired level indefinitely. At times countries try to maintain the value of their currency at higher values than they are worth. This has the effect of making the imports cheap, rising the income level of the people of that country. In our context the opposite applies. The Chinese officials have kept the value of the yuan below the true value and thus making imports to be expensive and lowering the income levels of its citizens. This also makes the exports to be quite cheap. The effect this has on the country of china is that there is a stimulus for internal economic growth which will however need to be checked to avoid overheating. For this to be maintained the Chinese officials must continue to sell the yuan and buy foreign currency. It is claimed that china has over 711 billion US dollars in foreign exchange reserves. The willingness of China to keep more foreign reserves will enable it maintain the exchange rate for a considerable length of time. This is however done at some considerable risks of inflation (Ferrington 47).
The following chart illustrates how the Chinese official have kept the yuan at a lower value than its actual value. The red line shows a Beijing-manipulated exchange rate, and the blue line indicates the market's expectations for where the exchange rate will be in twelve months.
From the above graph it can be seen that prior to the year 2005 the yuan was kept at affixed rate. But due pressure from the US, the Chinese officials allowed the yuan to appreciate. The increase was approximately at 6 per cent per annum. However, carefully examining the above graph shows that the rise has came to a standstill as from the year 2008. It should be noted that in 2005 the Chinese officials introduced some crawling pegging which allowed them to still control the rate at which the yuam rose. The rate was constantly kept at a lower rate than the true rate at which the yuan could have rose.
It has been argued that the behaviour of China keeping its currency low without any regard to the economical consequences that results amounts to currency manipulation. However other views have been aired showing that the economical benefits which results from fixing the yuan is worth as it keeps the economic stability of China stable and the resulting benefits are shared among many countries. Still there have been more views that even those countries which have floated their currencies in a way manipulate their currencies by changing the interest rates and through other policies thus affecting the exchange rate of their currencies. The section below discusses the benefits which results from pegging the Chinese yuan to the dollar. This is significant in this debate as it will help to show whether the engagement of the Chinese officials in pegging the yuan to the US dollar is worth the cost.
Significance of the pegging the yuan to the US dollar
It has been argued that the pegging of the yuan to the US dollar has been in the interest of the two countries. Trading between China and the US began as far back as 1985 with the imports at this time to the US summing up to four million US dollars (UC census Bureau). Since then there has been a steady increase in the imports to US with the total sum of imports as for the year 2008 reaching 337.8 billion US dollars. The pegging of the yuan to the US dollars has brought much confidence to investors on the Chinese currency. This has led to many investors investing in china and stimulating growth that has been witnessed in that country today. It should be appreciated that this would not have been possible because the yuan at one moment was compared to be worthless as compared to the major currencies in the world. As it hhas been early above, the yuan value is not based on interest rates but is fixed. This is done by the Chinese officials determining the value of the yuan based on the Chinese bank's reserves requirements. As seen above, the yuan is not allowed to flow freely in the free market economy but rather the yuan price is held steady based on fixed exchange rate policy. Maintaining this policy makes it possible for the Chinese officials to tie the official exchange rate to another country currency. This is carried out with an aim of maintaining the value of the currency value at a very narrow border line and making it possible for currency fluctuations to be avoided. This has gained china a lot of criticism since it appears that it is the only country which seem to benefit from this arrangement. This is claimed to be so because the value of the yuan is lower than the US dollar thus forcing the US to pay the price. Chinese officials are opposed to appreciating the value of the yuan claiming that may lead to decreasing foreign economical activities in the country. If there is persistence decrease in the number of economical activities the average level of prices are also to fall and this will lead to deflation. The Chinese officials have therefore argued that abandoning the pegging of the yuan on the US dollar is not an option as this would result to an economical crisis in China as well as around the world (Zhang 5).
US lawmakers have been angered by this move from the Chinese officials have been constantly arguing on whether or not to label China as currency manipulator. However it should be noted that so far the US government has not taken any steps towards labelling China as currency manipulator. This is because there are many consequences this will have on the US economy. Labelling a country a currency manipulator will lead to some sanctions being imposed on the country which will include restriction on the amount of goods which can be imported from that country. If such happens then it has been argued that some states such as Washington would be weakened economically as they heavily rely on the cheap imports from China. Imposing sanctions on the Chinese exports would put the US economy in a fragile position economically. This has led made the US officials avoid labelling China a currency manipulator but rather have sought to putting pressure on the Chinese officials allow their currency to appreciate.
It has been acknowledged that Chinese exports have a significant effect on the global economy and therefore putting some sanctions on the Chinese exports by labelling the country a manipulator will somehow affect the global economy. In the US the Treasury Department has resorted to make a close monitoring of the yuan and constantly push the Chinese officials to take some steps towards implementation of acts meant to rebalance the global economy. Close monitoring of the yuan has shown that the yuan currency has risen in value by 18.4% against the dollar since the year of 2005. Still there are complains that the yuan is being allowed to rise in value but with some crawling pegging being attached implying that the rising in value is still being controlled. There have complains from US manufacturer that the Chinese yuan is still undervalued by as much as 40%. This has the effect of making the Chinese goods cheap as compared to goods manufactured in the US. By determining the value of its own yuan and overstocking US dollars, the Chinese currency has been strengthened making it possible for the Chinese economy to flourish amidst recession (Chun 180).
In reaction to all these complains especially from the US, the Chinese officials have responded by claiming that it is not right for the major economies to keep their currencies weak. The officials are arguing that the criticism directed towards the Chinese yuan is being carried out at the wrong time- a time when the yuan is making great contribution to the global economy. The officials argued that Chinese goods and resources are cheap and thus the best to help other economies around the globe to rebuild. The Chinese officials have pointed fingers at other major economies which are clearly involved in the devaluation of their currencies. (3) The Chinese officials gave evidence of the trade surplus imports which were growing faster though the exports remained closely constant to what it was back in 2008. This, they claimed, was a show that the yuan was not being pegged to the dollar for export benefits (Navarro 7).
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The US has constantly complained of incurring a lot of expenses brought about by the practice of devaluation of China's currency. The US claims to have lost more than 1.3 million jobs in the manufacturing sector to China within a span of ten years. It is a firm believe among the Americans that the artificially low yuan has a very unfair competitive edge towards them. Americans have also complained of trade deficit which usually result when there is a negative balance of trade due to imports exceeding exports. The yuan has made huge contribution of the trade imbalance seen between US and China whereby China exports more to US than what the US exports. The has made the US to experience a negative balance of trade which is the reason why the US lawmakers are pushing China to allow the yuan to appreciate as this will make the US manufacturers to compete with manufacturers. Though there has an appreciation in the value of the yuan, it is claimed that the appreciation of the yuan is not enough to make any significant change in trade imbalance being experienced by the US.
Using the above simple diagram it can be shown what will happen to US products. Taking the Y-axis to represent the price of the goods from the US and the X-axis to represent the quantity of the same goods demanded. From the diagram with lowering of the price of the goods there is an increased demand for the goods. This is likely to happen if the yuen appreciates in value and will help in correcting the balance of payments.
In the most recent report, China announced that it would allow a greater flexibility in the value of its currency, in order to relieve the tight tension between Beijing and Washington and also to resolve global criticism on China. China central bank has agreed to allow its currency to appreciate gradually against the US dollar. If the yuan do rise to a significant value, it will increase the buying power of its consumers and could make gasoline or other imported commodities to China seem less expensive. Over the past two months, the yuan has risen with the US dollar by 15% against the euro; this has worried the Chinese official about the future, as competitiveness of China's sales to Europe may be challeneged of which has never been an issue, and in addition with Europe being the biggest maret for Chinese exports.
Whether or not China decides to let its currency appreciate, there are both positive and negative aspect towards the long run and short run future. Although, through revaluing of yuan, US would be the first to benefit as their currencies are pegged with each other. Hence, unemployment issues would improve in the US, since US exports are able to compete. On the other hand, this may lead to consumers changing their suppliers - referring to European merchants buying from other suppliers rather than China, hence damaging the Chinese economy and putting a halt on to its rapid economy acceleration. In my opinion, I believe there are other factors to consider apart from purely money based issues. Through so much pressure from around the world to China over such a long period of time, it may be a right decision for China to act upon so, showing leadership and team spirit across the other nations. Broadcasting the message that it is a country with the capability to alter for further improvements. This would not only increase China's social status amongst the others, but also increase popularity in such that trades and other aspects of China would continue to rise and flourish.
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