China's Dangerous Overvaluation - Article Example

Summary of the Article The article is about the appreciation of Yuan against other currencies and starts with the news of recent slide in Yuan valueagainst US Dollar. Author indicates that despite all the signs indicating towards economic trouble for China, it may continue to use its policies to further strengthen the Yuan however; the same may actually backfire given how the different economic factors are indicating. A stronger Yuan and higher interest rates in Chinese economy will continue to put pressure on the currency as capital inflows increase and financial liberalization kicks in.

Author highlights the times when appreciating Yuan was a desired proposition for China to help the domestic consumption and rebalancing of domestic consumption required. Based upon labor costs and trade patterns, author is of the view that Yuan is certainly overvalued by approximately 15% suggesting that it’s time for China to take corrective measures. Author suggests measuring increasing labor costs as one of the indicators to measure how much the currency has appreciated and also cites the fact that labor costs have increased more than the overall profitability of the Chinese companies.

Author indicates that any further appreciation in the currency would actually be more harmful for the country because the overall level of debt has been creeping up in the economy which would ultimately hurt the domestic consumption in China. Author suggests that to arrest the appreciation of Yuan, one way could be to allow domestic prices to adjust to the appreciated Yuan however; this may result into difficult economic consequences whereas rebalancing from investment to consumption is recommended as an easier way to manage Yuan.

Critical Analysis Probably one of the biggest weaknesses of the article is the absence of any figures and data based upon which author made the claims. Almost all the arguments are without any solid economic data and most arguments are relatively theoretical in nature. It would have been much better had the author used the real economic data to point out the appreciation trends in the value of Yuan against the major international currencies specially US Dollar. It is also critical to note that China has basically not highlighted as to how an appreciated Yuan have been benefiting Chinese economy in maintaining healthy trade surplus besides emerging as the leading export oriented economy in the world.

An increase in the labor costs may not be one of the basic indicators of measuring the appreciation in Yuan. An increase in labor costs may also be due to the increasing specialization within the Chinese economy and the fact that Chinese workers may be gaining more advanced skills. Gaining more advanced skills invariably results into an increase in the overall labor wages. With more financial assets saved in the banking sector of the country, a depreciation of the currency would may mean consumers would be drawing more from their savings to meet with the inflationary expectations.

This will decrease the saving rates in the economy and would invariably result into decline in domestic consumption.