The Rate Changing Effects of Chinese Currency - Research Paper Example

RESEARCH PAPER The Rate Changing Effects of Chinese Currency RMB Prepared by: The People’s Republic of China is an independent situated in East Asia. It is the most populous country of the world. The population of China is about 1.35 billion which constitutes about 20% of the world total population. By area of land, China is the second largest country in the world. It covers about 9,600 thousand squares kilometers area of land. China has a diverse geography and landscape. In the north it has deserts like Taklamakan Desert and Gobi Desert. In the south, it has subtropical forests. The mountain ranges of Karakoram, Himalayas, Tian Shan and Pamir separate China from South Asia and Central Asia. In the north, China is surrounded by Russian Federation and Mongolia. North Korea is situated in the North-East. Vietnam, Laos, Burma, Bhutan, Nepal and India are situated in the South. Pakistan and Afghanistan are situated in the South-West. Tajikistan and Kyrgyzstan are situated in the West while Kazakhistan is situated in the North-West. The China’s border meet with 14 countries which keep the country directly connected with South and Central Asia. ECONOMY OF CHINA: China is a developing country. However, its growth rate is quite rapid and high. It is considered to be the world’s fastest growing economies. The reforms brought by the government opening up the market are considered to be a main factor of economic boom of the economy. The Chinese economy developed into the second largest economy in the world, after the United States of America, by the size of Gross Domestic Product (GDP); both in terms of nominal GDP and Purchasing Power Parity. The per capita GDP in 2012 was reached to $6,075 which was only $205 in 1980. The real annual growth rate of Chian GDP averages to about 10% through 2013. In the recent few years, China has come up to be the major trade and economic power. The China opened markets for the exporters and importers as well. $3.3 trillion have been accumulated in the foreign exchange reserves of the country which are the largest foreign exchange reserves accumulated by a country. The country was also ranked as the largest exporter of the world and the second largest importer. Thus, the Chinese economy is considered to be the largest trading economy and the largest manufacturer in the world. The gradual economic reforms introduced by the country, the constant opening-up of the markets for large quantum of imports and exports, the improved economic structures and the continuous introduction of improvements and high savings and high investments are considered to be some of the main factors that have contributed a lot in the economic growth of the country. The economic growth to such a huge extent has also affected many of the economic aspects of the Chinese economy. The main aspect is the growth in GDP. The economic growth also appreciated the value of Chinese currency. However, China introduced currency policy which limits the appreciation in Chinese currency against US dollar. Though, this limitation seems to keep the currency devalued that its original value but it has also brought several other benefits to China. CHINESE CURRENCY: Yuan or Renminbi (RMB) is legal tender currency of the People’s Republic of China. The word Renminbi literally means the “people’s currency”. The currency is issued by the China Central Bank known as People’s Bank of China. The currency is officially abbreviated as CNY. However, the abbreviation of “RMB” is also commonly used. The currency comes into the denomination of 100 yuan, 50 yuan, 20 yuan, 10 yuan, 5 yuan, 2 yuan, 1 yuan, 5 jiao, 2 jiao, 1 jiao, 5 fen, 2 fen and 1 fen. The coins are denominated in 1 yuan, 5 jiao, 2 jiao, 1 jiao, 5 fen, 2 fen and 1 fen. The Chinese currency (RMB) has appreciated in value since after the reforms introduced in 1979. The appreciation was steady and constant. It was also indicative of the consistent economic growth and financial stability of the Chinese economy. The data pertaining to the Chinese currency exchange rate relating to the 10 years period starting from April 19, 2004 to April 16, 2014 is shown in the graph below. The graph shows that the exchange rate of Chinese RMB against American USD has decreased constantly. The dollar was above 8.0 yuan in 2005. However, this rate was decreased and reached below 7.0 yuan per dollar in 2008. During the economic crisis of 2008, the value of Chinese currency neither appreciated nor devalued and remain at the same price of below 7.0 yuan per dollar for two years till 2010 when the yuan again appreciated and consequently, one dollar price reached below 6.5 yuan in 2011. The Chinese RMB appreciated in the years following 2011 but the exchange rate did not fall below 6.0 yuan per US Dollar to date. Year Exchange Rate (Yuan/ USD) 2004 8.2664 2005 8.1838 2006 7.9646 2007 7.5972 2008 6.9404 2009 6.8212 2010 6.7605 2011 6.4544 2012 6.3034 2013 6.1905 CHINA’S CURRENCY POLICY: Before 1994, Dual system of exchange rate was running in China. It consisted of an exchange rate system that was officially fixed and was used by the government and another system of exchange rate that was market-based and was commonly used for trade purposes. Significant differences occurred between the two rates. So, in 1993 the dollar was 5.77 yuan under official exchange rate system while in swap markets, it was 8.70 yuan. In 1994, the two systems were unified by the government and the dollar was initially set at the rate of 8.70 yuan. The currency was allowed to appreciate to 8.28 yuan per dollar by 1997. This rate remains relatively stable by July 2005. The relative stability was achieved through China policy to peg RMB to US dollar at a stable exchange rate of about 8.28 yuan per dollar. The stable financial environment provided by pegging promoted investment and foreign trade in China. The peg was maintained by the Chinese central bank by selling or buying of assets which were dollar denominated in exchange for yuan to remove any difference that might cause fluctuations in the currency rates. In July 2005, the currency policy was modified by the government whereby the exchange rate of RMB was allowed to be modified on the basis of demand and supply and movements of exchange rates in the market. However, the RMB was not allowed to fluctuate by more than 0.3% in a day. The RMB started appreciating steadily and slowly after July 2005. By July 2008, the RMB had appreciated to 6.83 yuan per dollar. Thus, the government adopted “managed float” to control the currency rate fluctuations whereby the free market forces determines RMB movement direction but the government slowed down the pace of appreciation through intervening in the market. The China policy of currency appreciation was halted around July 2008 due to the economic financial crisis. The crisis reduced the global demand for the Chinese products. Thousands of factories that manufactured products for export were shut down increasing unemployment. However, the government intervened in the market to stop appreciation of RMB to dollar. The RMB to dollar exchange rate remained constant through June 2010 at 6.83 when the Central Bank of China decided to advance with the regime of RMB exchange rate. The currency again started appreciating and reached to 6.17 by July, 2013. Though the currency has gone up and down after resuming of appreciation, overall the currency was appreciated. However, some economists argue that to measure the exchange rate between RMB and dollar more accurately, the inflation factor should also be accounted. Thus, they tend to focus the attention on real exchange rate. The approach seems to be justified as the prices of the Chinese trades will be rising if there is higher inflation in China as compared to U.S even if there is no change in nominal exchange rate. Thus, effectively, a higher inflation rate will appreciate the RMB. EFFECTS OF UNDERVALUED RMB ON US ECONOMY: China is economically growing quite rapidly. This enormous economic growth has resulted in bilateral business ties with the United States of America. At present, the trade between these two countries has reached to $558 billion in 2013 from only $5 billion in 1980 according to trade data of the United States. China is the second-largest trade partner of US. It is also the third largest market for the US exports. The maximum portion of the imports the US made is from China. Many US Multinational companies have started widespread operations in China to take advantage of rising Chinese markets and lower labour costs. These advantages have helped many US firms to remain internationally competitive and providing their customers with low price products. However, as China is emerging as an economic power, various concerns have been raised by the U.S. policy makers. Some of them claim that China is using industrial policies to protect and promote the interests of certain Chinese firms and industries who are favored by government. On the other hand, government is failing to take actions against the violation of U.S. IP (intellectual Property) rights in China. This failure threatens the competitiveness of the IP-intensive U.S. industries. Some contend that though China has become the largest market for U.S. exports, certain barriers exist that limit the U.S. firms opportunities to sell and trade in China. These barriers also force the firms to establish their business setups in China for operating there. Some critics also argue that to flood U.S. markets with low-cost Chinese goods, China is using unfair practices of Subsidies granted to the domestic manufacturers and undervaluation of currency. Due to these practices, the China exports to U.S are appearing to be less expensive than they would be if the free market forces were allowed to adjust RMB to dollar exchange rates. These practices threaten the living standards, wages and jobs of U.S. citizens. It is argued that the level of jobs in U.S. will boost with the appreciation in the value of RMB. There is a direct relationship between the U.S. job losses and U.S. trade deficits. The U.S. is facing trade deficits with China which is resulting in loss of jobs. The Economic Policy Institute Study claims that 2.7 million jobs were lost in U.S in 2012 due to trade deficit. The EPI also claimed that the major portion of this trade deficit was the result of Currency policy of China. The reports of EPI also stated that the U.S exports made to China support the jobs of U.S while imports from China cause loss of jobs. The use of pegged currency has also been contended as it would be appropriate to be used in the early stages of Chinese economic development. Under the present conditions of Chinese trade flow and economy, the peg currency did not seem appropriate to be used. Thus, the currency policy of China is affecting U.S to a great extent being the only economy larger than China’s economy. Thus, various bills have been initiated by America in order to induce China to formulate its currency policy so that it does not affect the U.S economy so adversely. A bill was also initiated in Congress whereby additional duties were proposed to be imposed on the imports from China unless the RMB is appreciated to the market level. The duties imposed were proposed to be 27.5%. the application of U.S. countervailing and anti-dumping duty measures to respond to the effects that under valued currency of China has on the US economy. These measures require that the difference should be treated as an export subsidy or as a factor which will be including while determining the anti-dumping duties. Consequently, the duties on imports of certain products from China may likely be imposed. U.S. Congress has also introduced certain Acts to deal with the matter. “The Currency Reform for Fair Trade Act: H.R. 1276” was introduced on 20 March 2013 in 113th Congress. The Act aimed to clarify the provisions in respect of countervailing duty laws relating to export subsidies provided by the foreign government. If the currency of such country is considered as fundamentally misaligned, the export subsidies provided will be treated as actionable subsidies. Another bill “The Currency Exchange Rate Oversight Reform Act of 2013: S.1114” was introduced on 07 June 2013. The bill is required to identify the currencies that are fundamentally misaligned and will also require the action to be taken to rectify the misalignment for the currencies of priority countries. EFFECTS OF UNDERVALUED RMB ON GLOBAL ECONOMY: The undervalued Chinese currency has also affected the other countries of the world besides U.S. The China’s undervalued currency has increased the exports of China to other countries of the world. It is also due to the low prices of the tradable goods that China produces. However, the imports of China from other countries are too low as the demand of these products in the country is also very low. This is due to the reason that the purchasing power of the Chinese workers’ is low due to undervalued currency and thus, they are unable to purchase high value goods imported from other countries. However, despite opposition from other countries, China remained stick to keep its currency undervalued as compared to other currencies of the world. EFFECTS OF UNDERVALUED RMB ON CHINA ECONOMY: The increase in the value of RMB may benefit China on some instances. For instance, appreciation in the value of RMB will definitely increase the purchasing power of the Chinese workers. The value of imports will be reduced and the workers will be able to access the products of the other countries imported in China as well. The companies operating within China will also be able to manufacture higher quality products as there will be a market for these products. The tradition of always competing on price may also be changed with the appreciation in value of RMB. US Treasury bills are also mostly purchased by China. Thus if the value of their currency is higher, it will be beneficial for them to purchase these treasury bills on low price. On the other hand, Chinese officials clearly state that the purpose of keeping their currency undervalued is not to prefer exports to imports. Rather, the main intention of government intervention is to gain economic stability through stabilizing the currency. The policy definitely reflects the goals of the government to provide job opportunities to the people through increasing exports. However, the main goal of the policy is to gain currency stability which will be achieved gradually in a long-run as stated by the government on a number of occasions. The government also argues quite strongly that the international pressure on China to appreciate currency is interference in the China’s sovereignty to frame and implement domestic policies. They also argue that such pressure and measures relating thereto taken by other countries against China hampers the economic development of China. The Chinese official also rejected the contentions of the economists that the China’s currency policy is destabilizing the global economy. These economists require that a sharp boost in the RMB rate is needed to recover the global economy. The Chinese officials responded with the argument that to boost the recovery of global economy, China must have take steps to promote the domestic growth rapidly. They factually state that the imports of China in 2010 was raised by 38.8% over the last year and in 2011, these were raised by 23.9% which contributed at large to the global economic recovery in these periods. The growth of exports in the year of 2012 an in the first half of 2013 were below the historic rates. The trade merchandise surplus also fell from 2009 through 2011 each year. The yuan was in equilibrium with the dollar in June 2013, CONCLUSION: The China’s currency has been appreciating against dollar since 2003. The appreciation has been 34% and 42% on nominal and real basis respectively. In 2011, the RMB was evaluated by IMF to be substantially undervalued. But in the years 2012 and 2013, the RBM was evaluated to be moderately undervalued. The global economic recession decreased the demand for Chinese products. The IMF, World Bank and some other global institutions warned China that it has promoted non sustainable policies in order to achieve gross fixed investment to a high level largely financed by policies of easy credit. The non-performing loans level may be increased weakening the financial sector. They have required China to focus its attention to implement policies through which private consumption may be made the main source of economic growth. The adoption by the Chinese government of the determination of the exchange rate by free market forces may be critical in the process. The Chinese officials have agreed to take steps to make the required reforms and also announced a number of policies for this purpose. The implementation of economic reforms and rebalancing of the economy of China are likely to lead to improve the commercial relationships between US and China and also play their part in global economic recovery and long-term global economic sustainability. This will benefit not only US and China but also many poor countries that need this indirect assistance from these two large economies of the world. REFERENCING: REFERENCES 1. ChinaToday.com. A China Information Base. Chinese Currency RMB (Chinese Money). Web. 16 April, 2014. 2. Wayne, M. China’s Economic Rise: History, Trends, Challenges, and Implications for the United States. Congressional Research Service, 03 February, 2014. Web. 16 April, 2014. 3. Briney, A. About.com. Geography of Countries Bordering China. 14 February, 2014. Web. 16 April, 2014. 4. Calp. The Impact of the Chinese Currency. 24 August, 2013. Web. 16 April, 2014. 5. Wayne, M & Marc, L. China’s Currency Policy: An Analysis of the Economic Issues. Congressional Research Service, 22 July, 2013. Web. 16 April, 2014. Read More