China’s Renminbi: “Our Currency, Your Problem” Essay

Our Currency, Your Problem is a case involving the distinguish of give-and-take rate regimes and the impact cash manipulation has on economies and portion out. The coupled States and Europe argued that the Renminbi (RMB) was undervalued and claimed that the Peoples Bank of china (PBoC) deliberately manipulated the metamorphose rate to lower the prices of exports, which caused the US and Europe to run huge substitute shortages with china. The US and Europe felt that the RMB was undervalued for several reasons.One reason is that Chinas exports had dramatically increased, growing 30% from 2004 to 2005, making China the thirdly largest exporter in the demesne and accounting for 6.5% of the worlds export. Another logical argument was that Chinas inflow of FDI had become the second largest in the world by 2004. The Chinese argued that their currency was not undervalued, that the policy of the PBoC benefited the US by helping them finance its huge budget, that even though they ran trade surpluses with the west they ran deficits with Asian countries, and that a low currency rate benefited multinational companies expend in China. Meanwhile, Japan and the newly industrialized economies (NIEs) including Taiwan and South Korea were less(prenominal) vocal than the US and Europe because they had become so economically colligate with China.They had invested themselves in China, thus an undervalued RMB would maintain operating cost low. Additionally, Japan and the NIEs ran trade surpluses with China and received essentially most of the benefit of value added figure out trade with China. When choosing an exchange rate regime, countries can operate between twain primary exchange rate systems. The first is a hardened exchange rate where the currency is strongly fixed to another value or pegged within a particular band and the rate is adjusted from prison term to time to stay within the defined or pegged range. The second is a vagrant exchange rate where the rate is allowed to depreciate or revalue based on the market. Both of these systems behave advantages and disadvantages. A fixed exchange rate regime will offer an economy greater perceptual constancy in international prices and therefore encourage trade.Additionally, for developing countries a fixed rate will assist in promoting institutional discipline as the country will adopt restrictive m startary and fiscal policies that cling to an anti-inflationary environment. A significant weakness of a fixed rate is that it is state to destabilizing speculative attacks which could lead to financial meltdowns and devastating economic contractions. A floating exchange rate regime allows central banks to combat macroeconomic factors such(prenominal) as unemployment, inflation, and interest rates without having to worry about the effect on exchange rates. except, developing countries whose economies depend on trade will be reluctant to allow their exchange rates to fluctuate freely. In 1994 the Chinese government made the decision to peg the RMB to the US dollar at a rate of US$1 to RMB8.7, a year afterwards the Renminbi appreciated 5% and was revalued to RMB8.28.This rate would remain unchanged for the next 10 years, even though the Chinese faced heavy scrutiny and squelch to revalue their currency. The Chinese exercised many policies in maintaining their exchange rate. The PBoC controlled the amount of irrelevant currency by forcing all exporters to immediately sell their outside(prenominal) currency to designated banks. The RMB could only be traded on the China Foreign Exchange calculate Trade System, which was exclusive to the designated banks. Furthermore, China mandated daily foreign reserves to nub reserves ratios forcing the member banks to either buy or sell foreign reserves.After absorbing foreign currencies in circulation, the PBoC reinvested these funds in US treasury bonds and stockpiled US debt in order to maintain the peg to the US dollar agai nst natural market forces. Maintaining an undervalued exchange rate also allowed Chinas economy to continue to grow. Foreign Direct Investment in China grew from $4.4B a year to $63B a year from 1991 to 2006. For every one dollar earned China would put 8RMB into circulation. This over supply of RMB also maintained the RMB artificially low. However, over time this policy of overabundance property could lead to inflation. China combatted inflationary pressures by issuing bonds thus removing excess RMBs and by imposing tighter liquidity ratios on banks. On July 2005 China reluctantly reformed their exchange rate regime. The renminbi was revalued by 2.1% to RMB8.11 to the US dollar.The peg to the US dollar was dropped and replaced by a peg to a basket of currencies. However the basket was predominately represented by the USD, the Euro, and the Yen. Despite this reform the US continue to lead international efforts in pressing for greater acceleration of the renminbis revaluation as tr ade deficits with China continued to increase. The Chinese claimed that if a major revaluation took place, such as 15%, it would level their exports create a contraction in exports. Such dramatic measures would surely have an impact on international trade. For example, the US would see their trade deficit shrink while Japan and NIEs would see their exports decrease. Therefore I cogitate that China should address their revaluation in a conservative but yet progressive approach. Forcing a major economy to do a one-time 10%, 15%, or 20% revaluation could have detrimental and unwanted consequences to a fragile world economy.