currency, inflation, central-bankThe US has been for while accusing China of manipulating the price of its currency to what they say is an unfair low level.
But I don’t get how China could be manipulating its currency any differently than the US does. For China to drop the value of the yuan they would have to print more money. Right? But this is what any central bank would do and does, print money!?
Could China be controlling their currency in a different way? If so, how?
Also, I don’t understand how the low price of the yuan could be damaging for the US economy. A US dollar yesterday costed 10 yuan, and today with China printing more money it costs 11 yuan.
That would mean it is now cheaper for the US to purchase goods for a lower price but also over some time, that should increase the prices in China due to inflation so the dollar should be able to buy no more or less than it used to before.
You got it all right!
The Chinese central bank (seems to) peg its currency (chinese yuan =CNY) to the US dollar (USD). And pegging simply means that China sets a fixed exchange rate, which currently is around 6.3 CHY per 1 USD. Let's take a look at a plot of USD/CHY exchange rate. From the graph we indeed can conclude that the Chinese Central Bank interferes in its foreign exchange rate policy HOWEVER the exchange RATE DECREASED (which means that the CNY increased in value from 2004 when it was traded at 8.3 CNY/USD for a long time. That's a 25% increase in the value which roughly translates into the imports from China being almost 25% more expensive.
Policy implications: Artificially devaluing the yuan, the Chinese make their goods less expensive (because we assume the wages and costs are in yuans) and this boosts the Chinese exports. When Exports > Imports then we get a positive Net exports and the result is that the Central Bank of China increases its reserves of foreign currency. Now China has the biggest reserves of foreign currency in the world(which is a sign they don't know what to do with the money they make), the total value of their reserves being 3.18 Trillion US Dollars. That's a long way from ONLY US /$ 1.6 bln (not trillion) back in 1978. The reserves are impressing even on the per capita basis, if we consider that China has 1.2 bln ppl we get a sum of USD 2650. (That's almost like GERMANY USD 3212, and the German exports were until recently the highest in the world, the second being China) Here's an interesting map of the value exports of countries, and here's the reserves value that countries have accumulated.
Consequences of pegging the exchange rate: When a country pegs its currency it runs 2 risks: It can either: *OVERVALUE or *UNDERVALUE its currency.
If you Overvalue your currency (the case of Moldova in 1997) you soon end up depleting your reserves (and gold) and very likely defaulting on your international obligations with other undesirable consequences (it's interesting to take a look at the evolution of Moldovan foreign reserves ).
In the case of undervaluing your currency YOU LOSE CONTROL OF YOUR MONEY SUPPLY and therefore risk to create a higher than desirable inflation. Of course inflation depends on many factors: especially the excess production capacity or the availability of work force so it does not mean that by undervaluing your currency and pegging it you'll get huge inflation the next MONTH.
The value of a currency is affected by market factors just like any other good or service on the market. An increase in supply of the currency, a decrease in demand for the currency, or a combination of both factors can cause the value of the currency to decline.
Printing off more currency would represent in increase in supply and would cause the value of the currency to decrease. Likewise decreasing interest rates would tempt investors to pull currency out of a given market and invest their capital elsewhere.
In a free market the value of a currency would be allowed to rise and fall. China is accused of not subjecting their currency to market conditions but rather pinning it to the US dollar. Specifically ensuring the yuan is relatively cheaper than the US dollar.
Since the dollar has a much higher relative value than the yuan it’s cheap to buy Chinese goods and services in US dollars. Likewise since the yuan has a low value relative to the dollar it’s expensive buy US goods with the Chinese yuan.
All of this leads to a situation where the US imports more goods from China than it exports out to China. Meanwhile China exports more goods to the US then it imports in.
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