Suppose that the Chinese central bank has been intervening in the foreign exchan

Question

Suppose that the Chinese central bank has been intervening in the foreign exchange market, buying U.S. dollars in an effort to keep its own currency, the yuan, weak. If China decided to allow the yuan to float freely, what would you expect to happen to each of the following?

a. U.S. exports to China would (?) (not change), (decrease), (increase).

b. U.S. imports from China would (?) (not change), (decrease), (increase).

c. The U.S. trade deficit with China would (?) (narrow), (widen), (not change).

Explanation / Answer

a) U.S. exports to China would not change because when US will export something to china, US will get the payment in US Dollars not in chinese Yuan, so whatever the exchange rate may be there would be no change in exports, because the payment has to be made in US dollars.

b) U.S. Imports from China would increase because the payment to china would be made in Yuan, and in the free float market the yaun would appreciate because earlier the central bank was intervening in the forex market to keep yuan weak, but now in the free float market the price of yuan would adjust and will come to its appropriate value and will appreciate in terms of dollars. So, now US would have to pay more yuans for the imports.

C) The U.S. trade deficit with China would widen because the excees of imports over exports, there would be no change in the value of exports but for imports US would have to pay more, thus the defecit would widen.

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