Chinese Currency Manipulation

The Chinese government have been criticised for the ‘manipulation’ of their currency. They would prefer not to use the word ‘manipulation’ perhaps they have an unofficial exchange rate target to keep Chinese currency undervalued to promote growth and exports. At the moment China only pegs its currency against the dollar and not a wider basket of currencies.When the UK was in the Exchange Rate Mechanism, we were trying to target a semi-fixed exchange rate. Though in 1992, we had to work hard to keep the Pound above its market value, whereas the Chinese are working to keep it lower.

Q. What does it Mean that the Chinese Currency is Undervalued?

An undervalued currency suggests that agents (i.e. Government) are keeping the currency below it’s ‘fair’ market equilibrium price by currency controls and intervention buying.

Many analysts argue that in a free market, the Chinese Yuan would appreciate because of the strong demand for Chinese goods and the large Chinese Current Account Surplus. However, the Chinese government is trying to prevent the currency rising. Essentially, the Chinese Central Bank is buying Dollar assets which increase the value of the US dollar relative to the Chinese currency.

This policy of buying foreign assets has led China to accumulate $2.4 trillion of foreign currency reserves. (China’s Foreign Currency Reserves)

Why is China Pursuing this Policy?

China is pursuing a policy of reducing the value of its currency to try and boost growth, especially in its key exporting industries. Chinese growth is very high by western standards. However, China needs a high rate of growth to absorb labour that is made unemployed from the agricultural sector. Because China doesn’t have much in the way of social welfare payments, it is concerned that without job creation in the manufacturing sector they could face high unemployment and social unrest. Therefore, keeping a weak currency helps to boost demand for Chinese exports and therefore Chinese jobs.

Why is US Unhappy at Situation?

By keeping the dollar strong, US exports become less competitive. Also by keeping the dollar strong to the Chinese Yuan, it makes Chinese imports relatively more attractive, increasing foreign demand at the expense of domestic producers. The US argues this loss of Demand and jobs is something it can’t afford at its particular stage in the economic cycle.

Large current account surplus is an indication that China’s currency is undervalued. Though this current account surplus has been decreasing in recent years.


27 thoughts on “Chinese Currency Manipulation”

  1. I wonder if the numbers for China’s BOP do indeed justify the allegations that China is manipulating its currency? I read up a little on how BOP sheds light on the issue but have gaps in my understanding, so any guidance is appreciated.

  2. U.S. Views on China currency:
    By Tadie
    The USA generally holds the view that China manipulates its currency by holding down its value versus other currencies ( notably the dollar ) to maintain its export driven economy, keep employment high in the base manufacturing sector and fuel economic growth – also adding to its massive holdings of foreign currency reserves ( held in dollars, euros and yen ).
    The base thought in the USA and its Euro allies is first and foremost a political one – that they ( the USA and Europe ) have been losing their manufacturing base to China over the past decade since China’s entry into the World Trade Organization ( WTO ) and gaining MOST FAVORED NATION STATUS ( for trade ) in the USA. The thought is that China offers a massive labor pool at inexpensive rates. Also, lax enforcement or non existence of environmental laws also is attractive to firms in the USA and Europe.
    The concern on political types in the USA ( the U.S. Congress and President ) is one of a political nature. The citizenry ( voters ) are upset regarding the current economic situation and high unemployment in the USA. It is worth noting that in the first half of the decade ( 2000 to 2005 ) there was little concern and even less talk of China’s growing economic power.
    Part of the problem is that Americans fail to note that they themselves are part of the problem. It’s a “chicken and egg” issue. Americans say “everything is now made in China” but China will say “your companies came here for cheap labor to increase profits”. It’s well worth noting that Americans do not have to buy Chinese made goods. It’s also worth noting that they don’t want to pay the necessary price to “buy American”. It’s the old political problem where everyone agrees we have to “kill some cows” but nobody wants to kill their own cow. Everyone expects someone else to sacrifice.
    Now, to say China “manipulates” its currency is my view absolutely true. However, the same can be said of the USA and every other large economy ( Japan, Germany, the UK, etc ). The other countries just do it in another manner – they use deficit spending, essentially increasing the supply of their own currency ( printing money ) which like an over supply of any commodity ( and money is a commodity, a fiat one, but a commodity none the less ) creates an imbalance in the “market” and hence drives down the price, or in this case the value of the currency.
    Countries do this for an obvious reason, to drive exports. China does the same thing. The problem countries have with China is that China seems to be winning this game, for the time being.
    Now, the problem for the other countries if China decides to allow its currency to rise in value ( perhaps by as much as 40% ) is that China’s purchasing power increases exponentially overnight. Let’s think of one of those base products in the world that is priced in Dollars – Oil. If China’s currency rose in value by 40% versus the Dollar overight then the price it pays for oil on the world market would be 30% less ! That economic dynamic alone could create massive problems for other economies – most notably the ability of China to acquire massive reserves and essentially hold huge power over the precious and finite supply and production of energy – which all the industrial economies ( most notably the USA ) depend upon.
    If China did control or have a large share or the ability to purchase large reserves or production they could essentially hinder or even cripple western economies by either denying access to current supplies or driving the price so high that it creates crippling economic effects in those economies ( inflation, reduced production ) and hence even more dependence on China exports.
    Unfortunately, for the west, politicians are prone to “play” to the voters and follow “mob” thought – that is to say and do what popular opinion dictates, rather than having a reasonable discussion of the repercussions of what such actions could cause in consequence.
    It sounds good to “bash” China now, especially since our economy ( and the west as a whole ) is suffering the malaise of the financial meltdown of the past decade. Perhaps it’s part of our culture – it’s not our “fault” and we need someone to blame.
    There’s a real lack of knowledge on the American populace side as to world or domestic economics, perhaps in China, too. However, politicians in America are beholden to special interest groups, popular opinion and voting groups – so if less than a transparent message works then that’s what you run with all the way to the election.

    In America, the popular opinion now is that China cost us jobs, millions of them. I would say that is true. But, China has also kept interest rates low here ( by financing our massive government spending ) as well as supplying with inexpensive goods ( keeping inflation low ). You won’t hear that side of the argument here – it’s not what people want to hear. It’s not what the politicians or media “spin” in their message.
    To Americans its easy to say its China’s fault. In part it is, but American management and politicians instigated the problem.
    In general, in America, we just need somebody to blame. It’s the American thing to do.

  3. It’s a year old blog post, but it’s interesting to compare how it all turned out and you were right about most of the things. I think Chinese Currency is still undervalued.

  4. Would the demand for chinese goods be less if they increase the value of their currency? Will the other south asian countries and south americans’ ones can serve as the replacement?

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