Chinese Yuan vs the US Dollar - Essay Example

? Chinese Yuan vs. US Dollar Introduction Deng Xiaoping was a China’s reformist who initiated the country’s economic rice to the modern world of trade in 1980s. He led to the introduction of policies that resulted to opening up China economic relations at a global scale. The use of the Chinese Yuan as the legal tender and its pegging against the US dollar in the exchange markets contributed to the economic rise in the country. The Chinese Yuan is also referred to as the Renminbi that forms the core foundation of trading arrangements between China and the US (Zhang 2004). The use of the two currencies in trade began in 1985 on a bilateral arrangement between the two countries. In 2008, the volume of imports from China hit the $337.8 billion mark. The China government has increased the use of the Yuan in foreign trade over the years leading dynamism in its exchange rates with other world currencies. According to economists, the China government is suspected to devalue the currency in order to increase the competitiveness of their local industries. In addition, the Chinese Yuan is less flexible with respect to the exchange rate against the US dollar and other world currencies. An effort to increase the flexibility of the Chinese Yuan by the government has resulted to the use of the currency internationally. The objective is increasing the use of the currency and achieving its use as a reserve currency in the long term (Derosa 2011). The last five financial years indicate a relatively stable exchange rate between the Chinese Yuan (CNY) and the US dollar (USD). The table below indicates the official exchange rates posted in the two countries’ markets. The record shows how much one US dollar is equivalent to the Chinese Yuan Year USD Chinese Yuan 2009 1 6.8314 2010 1 6.7703 2011 1 6.4615 2012 1 6.3123 2013 1 6.1910 Since 2009 to date, the value of the Chinese Yuan has been increasing. This is indicated by the fall of the exchange rate between the Yuan and the US dollar. From the table above, the exchange rate significantly reduced from 1USD/CNY 6.8314 in 2009 to 1USD/CNY 6.1910 in 2013 . This shows that the Chinese Yuan is gaining value against the USD while the dollar is losing value against the Yuan. The significant changes in the exchange rate can be attributed to the control efforts of the Chinese Yuan flexibility in the exchange market by the Chinese government (Exchange-Rates.org 2013). From 2005 to 2008, the Chinese government allowed the appreciation of the dollar to 21%. However, the global economic crisis prompted China to stop the appreciation and regulate the exchange rate flexibility. From 2008 to 2010, the exchange indicated minimal changes since the rate was maintained at about 6.83 Yuan (Exchange-Rates.org 2013). Amid the then economic conditions, the Chinese government continued with their reforms in the exchange rate thus increasing the currency’s flexibility again. This led to an appreciation of the exchange rate leading to a loss of value by the Yuan against the dollar. The controlled flexibility of the Yuan leads to a slowed appreciation of the dollar against the Yuan. The slight change in the exchange rate of these currencies is caused by the fixed exchange rate regime maintained by China with regard to their currency. The depreciation of the US dollar over the years also contributes to the decrease in the exchange rate between the CNY and the USD. The USD has lost value against the Yuan and other major currencies across the world especially during the global financial crisis. The Chinese Yuan/US dollar exchange rate in 2012 portrayed several movements that ranged between an increase and a decrease in value of the Yuan against the dollar and the loss of value of the dollar against the Yuan. The table below shows the values of the exchange rates between the Yuan and the dollar. The values are on quarterly basis with the USD as the base currency (Wang 2009). Month (2012) USD Yuan January 1 6.6233 April 1 6.3077 August 1 6.3604 December 1 6.2223 (Exchange-Rates.org 2013) From the table above, the Yuan shows a significant increase in value between January and April 2012 in comparison to the US dollar at the exchange market. An increase in the exchange rate can be attributed to several factors in the markets. The drop in exchange rate between January and April showed an increase in value of the Yuan which brought about a consequent decrease in the value of the dollar in the market. During the month of April in 2012, the government of China allowed the Yuan currency to trade in a wider array against the US dollar than before. This was viewed as an effort to liberalize the existing exchange rate regime that allowed minimal flexibility of the exchange rate against the US dollar (Wang 2009). Consequently, the exchange rate became more market-oriented as compared to the previous controlled rate. The announcement and the implementation of the flexibility policy of the Chinese government with regard to Yuan led to the appreciation of the currency because of its increased demand. The US dollar gained value to settle from 1USD/CYN6.6233 to 1USD/CYN6.3077. In the following months after the announcement of the liberalization policy, the exchange rate of the two currencies did not move below or above 1% of the daily exchange rate (Exchange-Rates.org 2013). The months of April to August indicated minimal changes in the exchange rate between the Yuan and the US dollar. The exchange rate did not show any significant increase or decrease of the value of the two currencies. Despite the option to allow a wider trading range and allowing the Yuan to fluctuate against the US dollar, the government ensured that there was a limit to the official rate of a rise or fall. The People’s Bank of China adjusted the limit upwards from 0.5% to 1%. Economists asserted that the widening of the trading bank by China was an effort to increase the volatility of the Yuan against the dollar since the daily exchange rates were determined by the markets. In addition, several Chinese officials have also pushed for the increase in the flexibility of the Yuan. The Yuan has also stagnated during this duration because of the shrinking of China’s surplus and capital inflows (Morrison, Labonte & Sanford 2006). According to various experts and officials, the stagnation can also be attributed to the approach of a possible equilibrium level of the Yuan against the dollar. The August to December period registered a further increase in value of the Yuan against the US dollar. The value increased from the previous 1USD/CNY 6.3604 to 1USD/CNY 6.2223. This indicated a decrease in value of the dollar or appreciation in value of the Chinese Yuan. The increase in value of the Yuan is partly attributed to the previous efforts made towards widening the trade band of the Yuan and its increased usage in international trade (Exchange-Rates.org 2013). In addition, China government has made efforts to create policies that would guarantee a reasonable monetary-base growth and maintain satisfactory liquidity to permit companies to obtain loans. The improved use of the Yuan on loans and transactions led to the increase of its value. This is because of the increased demand of the currency to the economies as compared to the relatively stable supply of the US dollar (Neelankavil & Rai 2009). Moreover, the view of traders and the government on Yuan and its closeness to its fair value led to increased usage in trade. This is because all business people believed that the use of the Yuan presented lower risks because of its stability in the exchange rate. As a result, the Yuan registered more movements in transactions across the markets. An increase in the use of this currency led to the increase in its value. The China government also aims at replacing the dollar usage as the most transacted currency in Asia and other parts of Europe. The objective is to make the Yuan the preferred currency for all business transactions made in these regions. Various policies have been put in place to kick-start the efforts to continue increasing the Yuan usage. Allowing the flexibility in the exchange rate and increased demand and usage of the Yuan caused the drop in the Yuan/US dollar exchange values. Currency flexibility in usage is one of the factors that affected the movements of the Chinese Yuan in the year 2012. The foreign exchange rate of the Yuan against the US dollar has been contentious since China and US got involved in the bilateral trade dealings. For a long time, the US government accuses the China government of manipulating the currency exchange rate. The US asserts that China does not allow a market free exchange rate thus disadvantaging their balance of trade and import costs. This is because economically, fixed exchange rate of the Yuan leads to cheaper exports from China. This is considered as an unfair trade since the US government believes that at market exchange rate, the exports ought to be more expensive. Correspondingly, the China imports become more expensive disadvantaging the US’s balance of trade. The US government has made numerous efforts to make China adjust its currency flexibility to no avail. The China government on the other hand has not responded to the negotiations and threats posed by the US on the Yuan flexibility. Instead, the China government reset their exchange rate to 1USD/CNY 6.3598 (Exchange-Rates.org 2013). Discouraging flexibility of the Yuan currency especially against the US dollar is one of the major factors that cause the movements of the Yuan against the dollar (Morrison, Labonte & Sanford 2006). Trade balance is the second factor that affects the movement of the Yuan against the US dollar. A trade balance is determined by the total value of imports and exports into and outside the country. When the total value of imports is higher that exports from a country, it is said to be an unfavorable balance of trade. A favorable balance of trade occurs when a country exports more than it imports to the country. China enjoys a favorable balance of trade with large values of exports to the US because of the low prices for all their industrial products. This form of positive trade balance affects the demand and supply of the Yuan. The favorable balance of trade leads to an increased demand for Yuan by the US buyers. This leads to an increase in the value of the Yuan against the US dollar in the long run. A trade deficit as experienced by the US with regard to its bilateral trade with China leads to a decreased demand of the US dollar. Consequently, the US dollar depreciates in value with respect to the Yuan. This explains the Yuan movements during the fiscal year 2012. The central bank actions are among factors that affect the movements of the Yuan exchange rate against the US dollar. China’s central bank known as People’s Bank of China has been a key player in determining the exchange rates of the Yuan against the US dollar. The bank is known to allow a wider trading range and allowing the Yuan to fluctuate against the US dollar in April 2012. The government ensured that there was a limit to the official rate of a rise or fall. The People’s Bank of China adjusted the limit upwards from 0.5% to 1%. Moreover, the bank plays an important role in controlling the interest rates on loans extended to businesses in China. These measures are aimed at controlling the economic growth of China. These controls directly affect the exchange rates of the Yuan against the US dollar (Morrison, Labonte & Sanford 2006). Companies operating in the retail industry and operating in the Chinese Yuan currency regions face the risk related to continued appreciation of the Yuan. Majority of the companies in this industry has resulted to settling most of their transactions using the Chinese Yuan. However, most of the imports done are paid in the US dollar currency. There is a risk of imminent fluctuation of the Yuan because of its unofficial pegging to the US dollar in the foreign exchange markets. Experts believe that the manipulation done to maintain the exchange rates between the Yuan and the US dollar gives the wrong impressions on the stability of the Yuan. Lack of flexibility in its usage and value determination by the market dynamics makes the Yuan vulnerable to major fluctuations (Chen 2009). A negative fluctuation of the dollar to the Yuan risks driving most exporters in the retail industry out of business. This is because the goods exported would experience massive losses in an event that the Yuan appreciates beyond the current exchange rate against the US dollar. In order to avoid this risk, the companies should make their all their payments in one single currency. This way, the exporters especially would avoid any losses that result from fluctuations of the exchange rates between these currencies (Hicks 2000). In addition, companies in the multinational retail industries should not have confidence on the central bank actions in controlling the Yuan/US dollar exchange rate. These companies face the risk of unexpected fluctuations of the Yuan that can result from the limits of pegging power of the central bank of China. This is because the pegging power of a given currency only lasts as far as the central bank’s ability. Relying on the central bank of China to sustain the stability of the Yuan to the US dollar is risky for companies in this industry. The companies should take precautions through hedging their transactions in order to keep their funds safe from a possible fluctuation of the Yuan. On the other hand, the companies in the retail industry should be aware of the risk of a possible unfavorable balance of trade between China and the US. Currently, the value of exports from China exceeds the imports to China from the US. However, a possible fluctuation of the Yuan may lead to decreased exports and these risks the exporters’ transactions. To prevent such occurrences, companies should ensure that exports are hedged to prevent latent losses (Hicks 2000). The Chinese Yuan is being used for many trade dealings in China, Asia and other parts of the globe. Its use is attributed to the strength of China’s economy and the stability of the Yuan. The usage and stability of the Yuan creates a possibility of appreciation in value against the US dollar and other world-traded currencies in the next 2 years. Continued bilateral trade and favorable balance of trade experienced by China today gives the Yuan a stable foundation to continue appreciating. The stable economical and political business environment in China also contributes largely on the stability and prospective appreciation of Yuan. The policies formed by the China government regarding the Yuan flexibility and usage create the basis for the Yuan to become one of the major reserve currencies in the global financial markets (Minikin & Lau 2013). In Asia, most of the cross-border transactions are being conducted using the Chinese Yuan quickly replacing the use of the US dollar. These changes in the Asian markets form a better foundation for the appreciation of the Yuan against many other major currencies in the markets. For instance, the “Asian Economic Integration” Monitor and the Head of the Asian Development Bank asserted that majority of the countries conducting bilateral trade with China uses the Yuan in settling all transactions (Zhang & Chan 2011). Its extensive use across Asia and other countries such as Japan and Singapore makes the Yuan a good currency in conducting businesses. This is because its stability offers business individuals with confidence in cross-border operations and minimal exposure to foreign exchange risks. References Chen, James. (2009). Essentials of Foreign Exchange Trading Epub Edition. John Wiley & Sons Inc. Derosa, D. F. (2011). Options on foreign exchange. Hoboken, N.J, J. Wiley. Exchange-Rates.org. (2013). Chinese Yuan Renminbi (CNY) to 1 US Dollar (USD). [Online], Available, http://www.exchange-rates.org/history/CNY/USD/T [Accessed 19 April 2013] Hicks, A. (2000). Managing currency risk using foreign exchange options. Boca Raton, CRC Press. Minikin, R., & Lau, K. (2013). The offshore Renminbi the rise of the Chinese currency and its global future. New York, Wiley. Morrison, W. M., Labonte, M., & Sanford, J. E. (2006). China's currency and economic issues. New York, Novinka Books. Neelankavil, J. P., & Rai, A. (2009). Basics of international business. Armonk, N.Y., M.E. Sharpe. Wang, P. (2009). The economics of foreign exchange and global finance. [Berlin], Springer-Verlag. Zhang, P. G. (2004). Chinese Yuan, Renminbi: derivative products. New Jersey, World Scientific. Zhang, P. G., & Chan, T. (2011). The Chinese Yuan internationalization and financial products in China. Hoboken, N.J., Wiley. Read More