Was Chinese Yuan Politically or Economically Motivated - Assignment Example

Running head: Yuan Revaluation case study Name: University: Course: Tutor: Date of Submission: Value of Yuan if were to be revalued by 20% If the Yuan was to be revalued by 20% , or more then the Yuan’s value will be 6.90/ U.S. dollar. The 20% revaluation would have constituted an increase in the value of the Chinese Yuan against the U.S dollar by 20%. In addition, Yuan revaluation by 20% would automatically increase the strength of the Yuan in relation to the United States dollar (Stephanie, 2010) .The increase in the strength of Chinese Yuan over the U.S dollar as a result of 20% revaluation would have made the Chinese goods more expensive for individuals to purchase as well as it would have lead to an increased manufacturing and outsourcing costs to China. This therefore implies that, the value of the U.S dollar per Yuan would be equivalent to .14/Chinese Yuan (Antweiler, 2010, pp.5-23). Moreover, the 20% revaluation would have lead to a decreased buying power of the U.S dollar which would eventually minimize trade deficits between the United States and China. Calculations If revaluation by 2.1% = Yuan 8.28/&-Yuan 8.11/&x100=2.1% Yaun 8.11/$ Then what will be 20% This will be equals to S  1 - S 2 x100 S  2  Yuan 8.28/&-Yuan 6.90/&x100= 20% Yaun 6.90/$ Was Chinese Yuan politically or economically motivated? The reevaluation of the Chinese Yuan is seen to have been politically as well as economically motivated. To begin with, reevaluation of the Chinese Yuan can be seen to have been economically motivated which is evident from the public announcement of the People’s Bank of China on Reforming the RMB Exchange Rate Regime. From the public announcement the primary aim of reevaluation was meant to establish and improve the socialist market as well as China’s economic system ((Antweiler,2010,pp.5-23).Secondly, China’s current account surplus as well as financial account surplus had a significant room for currency management hence its revaluation was considered economically significant. Throughout the 2004 and 2005, the United States government had continued to urge China to revalue the Yuan from its decade long peg to the United States dollar of Yaun 8.28/$. The United States government argued that the growing Chinese trade surplus with the United States indicated that the Yuan was significantly undervalued hence revaluing the Yuan would lead to increased as well as rapid growth of the country. Since China is seen to be relatively cheap in terms of manufacturing costs, many multinational companies have established their companies in China hence reaping the benefits of low cost labour and production (Jeffries, 2006,pp.56-78). Economically, the revaluation of the Yuan would steer economic growth in China with many small manufacturers establishing firm’s within china since the Yuan would gain strength over the dollar making the cost of manufacturing more expensive (Black, 2004, pp.211-232).The increased costs of manufacturing eventually would discourage foreign multinational corporation investment though on the other hand it would encourage domestic investment. Economic Critics were against the revaluation especially the Chinese exporters and multinationals enterprises with core manufacturing bases in China(Antweiler, 2010, pp.5-23). From economic perspective a revaluation would possibly lead to an increase in the direct costs of goods which then would cause a decrease in their expected gross and operating margins in situations where the prices of the goods on the market are lower than the manufacturing costs involved. The impact of the revaluation therefore was expected to have both positive and negative effects on the Chinese companies with most of them suffering 2% increase in manufacturing cost in relation to the foreign market pricing(Antweiler, 2010, pp.5-23). Moreover, the Yuan’s new freedom to float incrementally over time presented many manufacturers with a new and growing operational risk from the current exchange rates over time. Most of the multinational companies like Mattel had invested in China for the main purpose of using China as a manufacturing company hence they had wished for the currency to remain relatively stable and cheap revaluation of the Yuan therefore would mean that in dollars or euro terms, the cost of goods sold would rise and the resulting margins and profitability reduced when those same products were sold in euro or dollar markets (Zhang, 2004,pp.3-11). For other companies such as Boeing, revaluation would have a marginally positive impact if any Boeing did little sourcing in China, but had been making larger and larger sales to china. The revaluation of the Yuan would slightly increase the purchasing power of Boeing’s Chinese customers, as it used U.S. dollar based pricing for its export sales, including those to China(Antweiler, 2010, pp.5-23). Other companies’ anticipated more complex competitive impacts since the revaluation was thought to be a small cost increase. Simultaneously, the revaluation of the Yuan was expected to give the Japanese yen a substantial boost in the international financial markets, driving the value of the yen up against the dollar and the euro(Zhang, 2004,pp.3-11). Socialism refers to a form of government which tends to favor equal distribution of resources across the government. Socialist government therefore tends to favor an economic market system which has market forces in place that dictate natural changes in the economy (Stephanie, 2010). From the Public announcement made by the People’s Bank of China on Reforming the RMB, China appears to hang on the socialist reforms of the 20th century which is evident that the move to revalue the Yuan is politically motivated. China therefore saw it more important to revaluate the Yuan with the emerging global economy where the market forces in some situations dominate change from the outside (Stephanie, 2010). Since China is a country which believes in socialism, revaluing the Yuan will help China manage the floating rate more effectively as well as free itself from trade barriers especially with the release of its connection to the U.S. dollar. The political sparring moreover had reached levels of veiled threats as the members of the U.S, Treasury had warned Chinese officials that a revaluation of at least 10% would be needed to prevent protectionist legislation in the United States. Moreover, by revaluing the currency although minor in size showed the government’s willingness to listen to its citizens and act according to their will. The move to revalue the Yuan therefore was seen as the political move to reduce pressures growing between governments while simultaneously starting the process of moving the Chinese economy into a prominent role in the global economy like other economies such as US dollar, Japanese Yen, and Euro(Zhang, 2004,pp.3-11). The Chinese economy has become increasingly integral to the economies of Asia, specifically to the economies of Thailand, Malaysia, Korea and Taiwan .In recent years a number of major industries have migrated from other Southeast Asian countries to China, so the revaluation of the Yuan alters the competitive dynamics in the region. Several countries immediately reacted by announcing exchange rate changes of their own. Hong Kong however maintained its peg to the dollar (Zhang & Chan,2011,pp.1-5). The Malaysian government within hours announced the introduction of a similar managed-float exchange rate regime like that of China, Malaysia had maintained a fixed exchange rate since the onslaught of the Asian financial crisis in 1997. Impact of rising risk on Chinese companies operations in the near future In business environment various multinational companies tend to face various risks when carrying out their individual businesses. Under the fixed Chinese currency rate, many Chinese exporters produced and sold their goods without worrying about the exchange rate risk hence the switch to floating exchange rate automatically exposed them to a new risk. Revaluation of the Yuan automatically was expected to expose China to various multinational risks. In relation to this, the Chinese multinationals were expected to face multitude of currency risks such as transaction exposure, operating exposure, and translation exposure which in normal circumstances are risks faced by multinational firms resident in floating currency markets like that of the United States, Japanese yen, and European euro (Marrewijk, Ottens, & Schueller, 2006,pp.23-40). The rising currency risk to a larger extend will affect every dimension of the sales growth, profitability, and general competitiveness in the near future. Since the revaluation of the Yuan meant increased global competitiveness the multinationals were expected to face a tough and challenging floating exchange rate regime. Though, many critics perceived the Yuan revaluation as a tool to economic growth, the fluctuating exchange rate was more risky for the Chinese multinationals than their current pegged currency system (Keith, 2010). This implies that the Chinese companies would face uncertainty in terms of what the Yuan will cost in various business operations. As a result of the Yuan revaluation, the United States and other Global MNE’s companies were expected to face increasing costs with the changes in the exchange rates. In addition, in the near future, the Chinese companies may be forced to be mindful of the current exchange rate risk brought about by their managed float of 0.3%.(Stephanie, 2010).The introduction of floating rate regime through Yuan revaluation would allow the Yuan to fluctuate up to a given degree eventually making the value of the Yuan to rise and fall depending on various economical factors. The fluctuations if not properly monitored by the Chinese multinationals could cause trouble for Chinese exporters leading to unnecessary losses especially when the value of the Yuan is lower to other currencies such as the dollar, Euro as well as Japanese Yen (Killion,2006,pp.191-256). When the value of the Yuan reduces relative to other countries currencies it increases exportation thus more goods tends to be exported from China to foreign countries where trade is competitive. This too has an effect when the value of Yuan is more than other countries currency it tends to increase importation from other countries (Fenton, 2005, pp.52-78). This is because multinational firms may choose to purchase cheaper goods produced in other countries. With foreign currency fluctuations, it is necessary for the Chinese Multinationals to manage them properly. This is because if the fluctuations of the Yuan are not managed properly by the Chinese multinational companies it could result in a negative trade balance especially when the relative value of the Yuan remains high. In order to deal with the rising currency risks Chinese companies should outset their budgets for the increased costs as well as offset these costs through taking arbitrage opportunities as well as speculative(Dutta,2006,pp.93-110). By using arbitrage as well as speculative opportunities multinationals would be able to deal with MNE’s from all over the world especially when serving sourced company in China. With the increasing opportunities for Chinese multinationals, the government of China should choose to base their currency system in a different currency rather than the dollar. This may include the Euro or any other currency since Europe is China’s biggest importer (Brigham & Houston, 2008, pp.541-560). Values of the Chinese Yuan that might be reached for 30-or 60 day period If the Yuan were to be revalued by 0.3% per day for a period of 30days against the U.S dollar assuming an initial value of 8.11/$, then the value of the Yuan would be 7.41/$.On other hand if the Yuan were to be revalued by 0.3% per day for a period of 60days against the U.S dollar assuming an initial value of 8.11/$, then the value of the Yuan would be 6.78/$. If the Yuan were to be devalued by 0.3% per day for a period of 30days against the U.S dollar assuming an initial value of 8.11/$, then the value of the Yuan would be 8.87/$. If the Yuan were to be devalued by 0.3% per day for a period of 30days against the U.S dollar assuming an initial value of 8.11/$, then the value of the Yuan would be 9.71/$. Calculations Appreciation over 30 days (Revaluation for 30 days) (8.11(1-.003)^30)=$ 1=Yuan 7.41 Appreciation over 60 days (Revaluation for 60 days) (8.11(1-.003)^60)=$ 1=Yuan 6.78/$ Depreciation over 30 days (devaluation for 30 days) =(8.11(1+.003)^30)=$1@Yuan 8.87 Depreciation over 60 days (devaluation for 60 days) =(8.11(1+.003)^60)=$1@Yuan 9. 71 References Antweiler, W (July,2005). Revaluing  the Chinese Yuan.Publisher:Pearson Prentice Hall,pp.5-23 Brigham, E., F & Houston, J., F (2008). Fundamentals of financial management.6th ed.Publisher: Cengage Learning, pp.541-560 Black,K., H (2004). Managing a hedge fund: a complete guide to trading, business strategies, operations, and regulations. Chicago: McGraw-Hill Professional,pp.211-232 Dutta,M (2006). China's industrial revolution and economic presence.Vol 2.Publisher: World Scientific, pp.93-110 Fenton, G (2005). A revaluation of the Chinese Yuan: the impact on U.S. and Chinese economies. Publisher: Georgetown University, pp.52-78 Jeffries,I (2006). China: a guide to economic and political developments.Vol 3.Publisher: Taylor & Francis, pp.56-78 Killion, U (2006). A modern Chinese journey to the West: economic globalization and dualism.Publisher: Nova Publishers,pp.191-256 Keith, B (2010). China Moves to Ease Strain with U.S, “New York Times. Sept 8, 2010.Retrived on 8th April from: http://www.nytimes.com Marrewijk C , Ottens, D & Schueller, S (2006).International economics: theory, application, and policy.Publisher :Oxford University Press, pp.23-40 Stephanie, F(2010). “Chinese Yuan flexibility comments buoy markets.”BBC News ( Jun 21, 2010): Retrieved on 8th April from: http:// www.bbc.co.uk/news/10362725 Zhang P & Chan,T (2011). The Chinese Yuan: Internationalization and Financial Products in China. Volume 678 of Wiley Finance. Publisher: John Wiley and Sons, Pp.1-5 Zhang, P., G (2004). Chinese Yuan renminbi derivative products. Publisher: World Scientific,pp.3- 11 Read More