China Case - Assignment Example

China Case Introduction The US government scored a victory in diplomatic row when the government of China confirmed their intentions of allowing the exchange rate that would occur between the dollar of United States to float, and the Yuan, or the reminbi (RMB). However, the proposal of the People’s Bank of China (PBOC) which is known as China’s Central Bank which was to end with what people thought to be a fixed exchange rate rule to the policy to fix the Yuan value beside the baskets of the currency.

This paper tries to analyze how the exchange rate policy of China, has been linked to its development, and the trade relationship that exists between US and China. The China’s exchange rate policy is linked to its development strategy. This is because China is a stable developed economy, which is centrally planned, and accompanied with a change in the exchange rate regime. Yuan had been fixed at an overvalued rate before the reforms were made. This was so to subsidize importing of goods that the China people could not produce internally.

Another development change took place very faster where, the people of the Central Bank fixed an official exchange rate, and the free exchanges were recommended on the markets. However, the official rate seemed to be higher than the rate of the market, which disadvantaged the domestic exporters. It did not take many years before the new rate was established again in the market, and this regime was to be part of the economic stabilization plans which aimed at facing the high inflation as well as, the boom of the credit.

The crisis of the Asian financial made the China people keep the exchange rate regime. They decided to exchange the incoming dollars for Yuan, and this was done at a fixed exchange rate. The result was to prevent the Yuan value from rising against the United States dollar (Herrero, Alicia, and Tuuli, p 104). There is no reason to delay floating until banking has been liberalized and the capital controls have been abolished. This is because people do not really know how long, or at what pace will the government of China let the Yuan appreciate, and if it does so, for how long is the country going to sustain the export-led strategy without having risking too much inflation, if the PBOC happened not to change monetary as well as, the exchange rate policy.

The Yuan to be kept undervalued was in a simple relative theory of the PBOC, policy to keep it undervalued. The central bank and the commercial bank were supposed to purchase the large amounts of the dollar-denominated assets so as to keep the dollar value high in relative to the Yuan, and it was accomplished when very large amounts of the U.S. Treasury bonds were issued by Freddie Mac and Fanny Mae. There are undesirable consequences of undervaluation, in that if the Yuan may be undervalued against the dollar, most probably there would be both the benefits as well as, costs to the economy of the U.S. It would mean that, the imported Chinese goods would be cheap rather than if the Yuan was determined in the market.

This seemed to have lowered the prices for U.S. consumers as well as, dampening the inflationary pressures. It also lowered the prices for U.S. firms that used imported inputs in their production, hence making the firms to be more competitive (Goldstein and Nicholas, p 126). Conclusion Many economists argue that, the undervalued renminbi may be the cause of the current surplus, and a cause of global imbalances which contributes to the global crisis. Most economists agree that allowing global current account imbalances, particularly the US deficit as well as, the Chinese surplus, and their accompanying capital flows contributed to the under-pricing of danger that enhanced the crisis.

Therefore, it is not recommended to let China people to stay the course and to revalue or to float since this might be very risky to them. Works Cited Goldstein, Morris, and Nicholas R. Lardy. Debating Chinas exchange rate policy. New Yolk: Peterson Institute for International Economics, 2008. Print. Herrero, Alicia, and Tuuli Koivu. Chinas exchange rate policy and Asian trade. London: Bank for International Settlements, Monetary and Economic Department, 2009. Print.