Question on pegging your currency to the dollar

Readers Question: Could you explain this article China had pegged its currency to the dollar, keeping its value artificially low.

To peg your currency against the dollar

This means that China has been trying to keep the value of its currency against the dollar the same.

For example, if 1 Chinese Yuan = 0.16 Dollars . ( 1 Dollar = 6.13 Yuan.)

Then China is trying to keep the Yuan close to this level. e.g. prevent the value of the Yuan rising.


Many argue that the Chinese Yuan is undervalued and left to market forces, the Yuan would appreciate 20%.  Then the exchange rate would be 1 Chinese Yuan = 0.20 Dollars (or 1 Dollar = 5 Yuan).

If the Chinese currency did appreciate then the currency would be no longer pegged against the dollar.

How To Peg the Chinese Currency Against the Dollar.

In a free market demand for Yuan would rise relative to the dollar. This would cause one Yuan to be worth more.

However, the Chinese government can intervene – selling Yuan and buying dollar assets. This intervention causes:

  • An increase in the supply of  Yuan
  • An increase in the demand for Dollars.

Therefore, the Chinese government are ‘artificially’ increasing demand for dollars. This raises the value of the dollar compared to the Yuan. This means the Chinese government can keep the value of the dollar higher than without their intervention.

Allowing the Yuan to Appreciate Against the dollar

..The People’s Bank of China said that in response to the global economy’s continuing recovery it will enhance its exchange rate’s “flexibility,” a statement observers interpreted as meaning that China will let the yuan gradually appreciate against the U.S. dollar.

If the Chinese authorities buy fewer dollars, then this will mean that the Yuan will start to appreciate relative to dollar. There will be a modest rise in the value of Yuan.

It sounds like there will be a small decline in the rate at which they buy dollars, therefore, there will only be a small rise in the value of the Yuan.

If they completely stopped buying dollars and started selling their dollar assets (e.g. US bonds) then there would be a rapid decline in the value of the dollar, and the Yuan would appreciate rapidly.

 

Related

Leave a comment

Item added to cart.
0 items - £0.00