Prior to the financial crisis in 2007/2008, the U.S. Treasury Department as well

Question

Prior to the financial crisis in 2007/2008, the U.S. Treasury Department as well as Congress had been asking China to revalue upwards the value of their Renminbi or Yuan. China responded to these repeated requests by allowing the Yuan to trade within a narrow band. The band itself was then shifted upwards or downwards by small increments from time to time. Still, the U.S. claimed that China had not done enough and should raise the value of the Yuan by at least a further 20%. The reasons given to justify this requested increase were as follows: 1.The artificially low value of the Yuan makes U.S. manufactured exports unattractively priced in China. 2.The undervalued Yuan leads to excessive U.S. imports of Chinese-made goods, which in turn, leads to an unwelcome trade balance in China's favor. For example, the trade deficit with China was roughly -$258,506.0 million in year 2007. These numbers shrunk further during 2009 as recession hit the global economy. In year 2011, the trade deficit with China was roughly -295,456.5 million (http://www.census.gov/foreign-trade/balance/c5700.html). China chose to change their 'floating' arrangement and pegged the Yuan to the USD at a rate they selected. China holds such a large investment in U.S. Treasuries as a result of the continuing U.S. trade surpluses that the U.S. does not have a great deal of leverage. If China sold those Treasuries the U.S. dollar would fall significantly in value. Discuss the issues involved with pegging or floating the Yuan to the US dollar.

Explanation / Answer

The main issues involved with pegging or floating the Yuan to the US dollar are as follows:-

1) Today most of countries have floating rate exchange system as determined by demand and supply forces in the international market however China is not having floating exchange rate system. This is one of the main issue with pegging or floating the Yuan to the US dollar.

2) The right value of chinese yuan is very difficult to estimate/measure as it has been substantially undervalued over the period/span of time.

3) Imports in china have become more costly due to undervalued nature of chinese currency i.e., yuan.

4) The exports made by china are very competitive in the international market as the value of chinese currency i.e., yuan is quite low.

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