Trade and Exchange Rate Policy with China - Term Paper Example

The paper “Trade and Exchange Rate Policy with China" is a forceful example of a term paper on macro & microeconomics. The economy of China has grown steadily over the past years to become the second trading partner of the European Union after the United States (Justin, 2011). The exchange rate of China is controlled by the government. The Central Bank of China-People’s Bank of India (PBoC) fixes the exchange rate between US Dollars and China currency (CNY) for a balance of trade (BOT) and balance of payments (BOP).  According to Salitan (2010), experts argue that the relation between China and the U.S has not been very warm and things do not seem to change in the future because they have conflicting interests.

A regime of exchange rates in China
According to economists in International Affairs at George Washington University, China has been able to maintain a stable fixed exchange rate against its trade partners from 1994 to 2005. However, after 2005 the Chinese government created a float according to an expert Wayne Morrison whereby the current behavior would be determined by the prevailing market forces. China has a strategy of making its exports to be cheaper and consequently results in them being appealing to many people (Salitan, 2010). However, the fixed exchange rate used by China has numerous effects as compared to if it was a flexible exchange rate. Some of these effects are illustrated as below; Firstly, if there is any pressure on the domestic currency (renminbi) to go up, it means that the government has to sell renminbi. This subsequently leads to an amount of renminbi in the local economy to increase hence inflation increases. Inflation causes instability in the economy. Secondly, it requires the China government to hold large reserves of foreign exchange. Moreover, money controls are necessary after-effects of ensuring that the exchange rates are stable. This, therefore, implies that the economy of China is not open and before any investment is made in China, there are several reconciliations and conditions that must be met.

The recent movement of Chinese RMB
The Chinese renminbi has been varying against the dollar recently. For example in 2012, the Department of Treasury (Justin, 2011) announced that it had allowed its currency to rise against the dollar. In the same year, the People’s Bank of India lowered its currency by 0.9 percent against the dollar. In the year 2014, the renminbi fall resulting in a loss of approximately 0.3 percent for its currency when it was compared with the dollar (Longjiang, 2011). Around March the same year, the People’s Bank of India announced that it would increase the amount by which its currency would be allowed to fluctuate by two times a move that was seen to be the growing desire for the Chinese government to make the renminbi an international currency. On July 3, 2014, the Chinese government allowed its banks to have their own exchange rate system. This was an attempt to make sure that the renminbi would change according to market forces.

These movements are to some extent associated with the negative trade account of the United States (Justin, 2011). China is able to manufacture products that are relatively cheaper as compared to America due to low payment of salaries to those working in China because of their low living standards (Longjiang, 2011). The other reason is due to the existing exchange rate that has been fixed to be below a dollar. The American industries are producing goods with higher prices and since America cannot block China goods, there will be a trade deficit and many people are getting unemployed in America.

                             Explanations for negative United States trade accounts

There are several reasons for the existing negative trade accounts in the United States. First, there is an increasing budget deficit in the country. This has led to crowding out effect on private investment and also increased the burden of tax payments by the future generation. Another reason is the decrease in savings among private individuals (Roger, 2005). This has led to a decrease in the GDP of the country and decrease in investment at a higher rate than the decrease in net exports. The overall effect has been disequilibrium in the balance of trade.

Moreover, in the U.S, the consumption rate is increasing at a higher rate than income. The high production growth has led to an increase in rate of returns hence domestic investment has increased and consumption. This has left little for saving and resulted to increase in the trade deficit. The other reason is an increase in investment by Americans in other countries due to the increased strength of the dollar. The last reason is due to the decline in foreign domestic demand which has lowered abroad GDP and therefore a decrease in the exports (Roger, 2005). This has an effect of increasing local investment and consumption and all this has led to negative trade accounts.

Conclusion
For the U.S o be able to restore their exchange rate defiance against China, they need to handle the dumping, low wages payments and labor rights. The U.S also needs to rebuild its industrial sector and offer new jobs. It also needs to negotiate with China on the exchange rate of their currencies. As for the Chinese government, it could solve the problems associated with the fixed exchange rate by mopping up the excess domestic currency in the economy by issuing government bonds. Thus, Justin argues that the money collected could be stored in reserves so that when there is a shortage of domestic currency the People’s Bank of China can supply it to the economy by buying the government bonds from the public.