Revaluation of Chinese Yuan Essay Example

legislation. Reason behind trade surplus For past 10 years Chinese currency was pegged with US dollar and the rapid transformation of Chinese economy brought trade imbalance with their biggest exporter , US. China became the manufacturing base for global source and thus attracted lots of foreign direct investment. Due to the competitiveness and cost of production with undervalued Yuan, the trade surplus with US became a major issue.

Reason behind foreign exchange With high trade of export and import using undervalued Yuan and FDI, China was able to accumulate billions of dollars in their federal reserve. This eventually helped China to purchase US Federal bonds of $190 billion by early 2005. In general, foreign exchange reserve is not negative for a country, but in the case of China it has reached the limit and this is forcing china to keep continue accumulate the Federal Reserve. By doing so, China was able to control domestic inflation and maintained the value of US dollar in the market. Appendix 2) corrective measure With the vision of moving Chinese economy into a prominent role in the global economy and the immense political pressure of US government, China government and People’s Bank of China officially changed the value of Yuan and thus removed the peg with US Dollar. Chinese Yuan had been pegged with US dollar since 1997 and this has sustained through the Asian Financial Crisis of 1997/98 and it also provided stable currency base for the rapid development of Chinese economy. The immediate measure taken by government to reevaluate the currency by 2. % can induce a rise in US interest rate which lowers US demand and also encourage

other Asian countries to allow their currency to appreciate against US dollar. This led to a lower export from China to US and thus retains the trade imbalance deficit between US and China. By removing the peg with dollar, china transitioned their currency to a floating exchange rate and joins the US Dollar, the euro and yen in the forefront of the global financial system. Due to the competitive implication China decided to reevaluate their currency from 8. 28Y/$ to 8. 11Y/$ and allowed the value to fluctuate 0. % per day over the previous day’s closing price. By doing so China was able to protect the investors and companies alike against large sudden changes and also prevented government intervention to rebalance this imbalance in the globalization scheme. For example Chinese multinationals like the Haier Group suffer only a 2% increase in cost versus foreign market pricing immediately. The Yuan’s new freedom to float 0. 3% helped them with a growing operational risk from exchange rates over time.

Applying the formula (8. 28 + 20%) = 9. 036 This means, the trade deficit of US with China will rise, China will be forced to keep on buying the US government bonds to control inflation. Meantime the export of china will rise and helps to the growth of economy in terms of foreign direct investment, Balance of Payments and Balance of Trade.