Background on Chinese Currency Debate

One of the consistently hot topics between China and the U.S. when it comes to the economy is that of the Yuan, the Chinese currency (also known as the renminbi). The country’s currency policy is a frequent topic in the news and a disputed one at that, so in this post I will briefly overview some of the issues at hand.

Modernized countries, such as the U.S., Japan, England, Germany, etc., operate on a “floating” exchange rate system. What this means is that their currencies, such as the dollar, fluctuate in value based off demand. So as more people view the dollar to be valuable and thus want to hold it, its price rises accordingly. On the flip side, if people do not think favorably of the dollar, its price falls. It’s “floating” in the sense that its prices are dictated by the market.

China’s currency in contrast is “fixed”, or in economic terms, “pegged.” This means that policy makers set a certain value for the Yuan, giving it no flexibility in regards to pricing. When pegged, the value of a currency is set in relation to a stronger, more stable currency. Pegging countries, which are typically modernizing nations, often turn to the dollar as a counterpart. China has done this since the early 1980’s, and which has allowed the country to experience controllable economic growth. Pegging one’s currency affords a great deal of control over an economy as it allows set prices, thus ruling out the possibility of excessive inflation that sometimes accompanies rapid growth.

For the entire duration of its relationship with the dollar, the Yuan has been set at a very low price. Thus, Chinese goods are relatively inexpensive for individuals using the dollar. This explains why 1/3 of all Chinese exports go to the U.S. On the other hand, although it is cheap for to buy Chinese goods with the dollar, it is extremely expensive to buy dollar-based goods with the Yuan. It is no surprise that Chinese imports are very low for a country of their size.

Having a general understanding of how different currency systems operate is key to grasping the main arguments both for and against the pegged Yuan. In the eyes of Americans, there are two approaches. First, many believe no problem exist since buying Chinese goods is so cheap. Taking a different point of view, many individuals, like American policy makers, believe Chinese goods are so cheap it hurts American producers. They claim it creates an uncompetitive environment since the prices are too low to compete with. The Chinese argue that they must keep their currency fixed at current levels so that they may have firm control over stability in the marketplace. There really is no right or wrong answer. It just depends on which position you take as a viewpoint. American product makers feel it’s unfair that China keeps prices artificially low, whereas other American companies love the fact they can buy their materials on the cheap.

In June 2010, China allowed their currency to float a little bit off of its fixed rate. Many American policy makers saw this seen as a step in the right direction, however much fluctuation still needs to happen. Currently, one U.S. dollar is worth 6.5689 Chinese Yuan, and the Chinese government has remained steadfast in claiming that they do not plan on changing their policies on currency anytime soon.

As the globalization discussions continue in regards to the U.S. and China, currency is certainly something to watch.

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1 Comment

Filed under Economy

One response to “Background on Chinese Currency Debate

  1. Daniel Benzecry

    It would be interesting to understand how China deals with its investments in the rest of the world. The question is if they lose purchasing power in the currency transactions when investing in dollar abroad.

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