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China’s Exchange Rate Policy Coursework


Introduction

China maintains a revoltingly under-valued exchange rate so that it can maintains the currency value directly at the level of the United States dollar. In the common fixed exchange rate method, this policy would bring about massive raises in the country money supply that would produce domestic inflation and finally wind down the surplus of payments and trade.

However, China has attempted to enable its payment and trade surplus through controlling the inflows of the foreign exchange using step-wise raises in the reserve needs of its banks with the central bank (Henning, 2008, p.39).

In around three years ago, China presented some changes to its foreign exchange policy and since then, the debate on the advantages and disadvantages of exchange rates policies in China, which had started many years before, strengthens.

But there are some negative effects brought about by these policies which have been already noticed, because sterilization of this kind has its restrictions. Inflation has been reported to be increasing in China where small businesses are experiencing some challenges as they look for credit.

Hence, China’s exchange rate policy limits its own businesses or firms. The effective way in which China should do to manage its country’s inflation is to allow the increase in its currency value, which would as well enhance real wages in the country’s economy.

By the start of 2010, RMB had appreciated by 22.2% against the United States and 4.5% against the European currency, matched up to mid 2006 after establishment of the RMB exchange rate development system reform (Brux, 2011).

China’s present trade surplus does not show RMB is rigorously underrated. In fact, economists do not have efficient means to examine if a currency is underrated or not. The current trade surplus as from 2006 is brought about by the over spending of the U.S. and does not result from China exchange rate (Goujon & Guérineau, 2007).

Reserved currency countries like China can face some of the drawbacks. The reserve currency will likely to be overestimated, harming competitiveness and expected China’s economic development, because of bigger demand for its monetary assets. Since financial policies contribute a lot to some countries, global political pressure will exist on the reserve currency countries.

Through fixed exchanged rates, monetary polices will be greatly restrained, as China has to absorb the currency holdings because of shortage of capacity of using them.

Through flexible exchange rates, this is probably to be slightly less of the difficulty likewise; a reserve currency country is apt to risk of higher unsteadiness of money demand (Kindler, 2004, p.28). This paper will report some pros and cons of some policies designed to promote and control exchange rates in China.

Discussion

Most of the countries in the world already understand that China’s exchange rates policy is perverse from an outside balance viewpoint. This huge and permanent case of mercantilistic monetary and exchange rate policy has not at all earlier been force on the international economy (Obstfield, 2005). In fact, it needed exchange management and insufficient free-market capital mobility to sustain this policy for a lengthier period.

Several countries are supposed to improve the quantity of the exports of the produced commodities to prevent recession.

However, the exchange rate technique for enhancing their competitiveness in comparison with Chinese producers are mostly not available to them, except if they are ready and capable of devaluing their currencies against the United States currency, and therefore against the currency of the China, provided the US exchange rate policy, this has never been helpful solution for several industrialized countries, many countries had to participate in the exchange market to balance appreciation difficulty (Corden, 2009).

The expansionary US monetary and exchange rate policy might not customize the exchange rate where its effect must have been highly could not change the one exchange rate where its impact should have been most marked, the exchange rate between the US dollar and renminbi (Goldstein, 2004, p.25).

The function of China on the demand part of the prime commodity market and its function in sustaining international demand for such goods through the latest recessions are important to prime commodity exporters such as Japan and Brazil (Goldstein & Lardy, 2009, p.47).

If China goes on to uphold particularly perverse policies, its inflation and recession Chinese inflation and the recession in some other countries may as well prolong.

Eventually, if it sustains its exchange rate against the United States currency, its competitive benefit will finally wind down, devastatingly for roughly everybody including the Chinese, through inflation. On the other hand, the smooth winding down of the China’s competitive stand would need suitable elasticity in the exchange rate between dollar and renminbi.

The upholding some policies which bring about trade disparities should stop if China is to turn into a completely operational participant of global payments system. The Chinese currency would not be the most valuable currency in the world except if China is under a shortfall in its payments and trade.

Valuable currencies merely come out in exceptional cases where a large economy, in which policies and purchasing strength are dependable for the continuing constancy, are under a continuing payments deficit, which then turn into surplus for everybody (Modigliani, 2009).

The current account surpluses in China affect several other countries’ recession, but higher identification of this fact, if combined with a double-dip recession (which other countries would face some challenges to handle provided policy exhaustion, deficits and debit), might bring about raised trade protection and also possibly a trade war. This is what the international economy would not prefer in the current state (Liew & Wu, 2007, p.22).

In the short-range, the international economy needs an immense Chinese purchase of Portuguese, Irish, and Greek superior union, but most understand that China, just similar to most countries, does not long to agree on the ‘haircut’.

Otherwise main Chinese business in the commercial banks in some parts of the Europe would as well be applicable. The absolute exchange rate inflexibility of the current European currency and the enforced inflexibility of the dollar against renminbi exchange rates create it exceptionally hard when rebalancing the global economy.

Policy Alternatives

China should consider using some of the policy alternatives so that it can enhance its economy and handle risks which are associated to exchange rates fluctuation. Most of the people in China consider that to strengthen its economy, China must emphasize on decreasing the net savings surplus through non-refundable revenue to households, raising country’s fiscal expenditure, and so forth and not just on customizing the exchange rate.

As China evidently should raise its present consumption, consumption is in the end restricted by income. China has bigger task in increasing the efficiency and wages of employees. Currently, domestic income contributes to merely 40% of the country’s income. The status is particularly severe to emigrant employees who do not obtain better education in the remote regions.

The earnings have never changed at a level of around $130 to $200 monthly for the last 30 years because of stable high unemployment for untrained labor (Brigham & Ehrhardt, 2010, p.699). Chinese savings are very high since the normal Chinese family is encountered with an extremely high return in investment like in housing sector.

In a research on the competitive long run return on capital for U.S., Japan, and China, they reported that China’s return on capital is around 25%, matched up to around 15% for Japan and 10% for U.S. during the last 30 years. Additionally, Chinese internal save to attain very high upcoming spending, for instance university education for their underprivileged children and retirement and health spending (Soofi, 2008).

Exchange Rate Policy on Global Economy

In the view of present global financial crisis, the economy of China has kept stable and rapid development. Which itself is a key involvement to the international economy strength. More specially, China’s involvement is mostly noticeable in two features.

First, investment policies which rouse internal demand and the equivalent international procurement not just aid main countries reinstate confidence, but as well encouraged the solidity and growth of China.

Secondly, allowing the RMB exchange rates appreciate firmly at a particular margin and place a fine example for the other countries and safeguard other countries from experiencing a severe currency-devaluation competition, therefore thus helping the international economy to improve after the financial crisis.

RMB Internationalization

Advantages

China is categorized as a developing country and the growth of the economy relies mostly on capital wealth. RMB Internationalization needs cautious examination of its advantages and disadvantages. Some studies have pointed out several advantages of RMB Key issues in China (Wang, 2011,p.35).

RMB Internationalization improves China’s global status and raises the impact China would have on the international economy. Meantime, putting the country’s currency in the international monetary system would help in changing the present status of being dominated, hence decrease the negative effect on China.

It will decrease the risks which are involved in exchange rate therefore encouraging China’s global trade and also investment. The rapid growth of international trade to international trade enterprise possesses huge international currency liabilities and claims. Greater risk as a result of currency exposure, the instability of the exchange rate will affect businesses to a certain level.

As the currency dominates and adjust, the risk of exchange rate experienced by businesses as well decreases, which can eventually promote China’s international investment and trade along with the RMB-denominated bonds. In addition, it supports the growth of border trade of China (Morris, 2007).

It eases the resolution of bilateral exchanges during the shortage of ways to support and enlarge bilateral exchanges of trade and economy to speed up the economic growth of rural and border regions. Moreover, several peripheral nations are wealthier in natural resources and this is the opposite of the state in China.

At the moment, China has a comparatively huge quantity of foreign exchange reserves, is in fact the same as the large non-performing loans of different countries’ governments and as well allows the inflation tax (Rajan & Thangavelu, 2009, p.127).

Disadvantages

RMB internationalization has effect on the stability of the country’s finance and economy. Internationalization of the internal economy of China is directly connected with the international economy; global financial markets would be any indication of difficulty for the effect of the country’s economy and finance.

RMB internationalization would make macro-control more complex. Through this, the global financial market will be a particular quantity of Yuan in distribution and the liquidity of its global central bank might deteriorate the management of Yuan and affect the establishment of macro-control policy outcomes.

The internationalization would raise Chinese currency management and controlling difficult. Due to the internationalization of RMB, the China’s central bank will raise the complexity of RMB money management (Brigham & Ehrhardt, 2010, p.43). The currency cash flows as well can raise the amount of unlawful practices in the China’s borders like gambling, corruption and other criminal practices there.

With these unlawful practices, the uncommon RMB cash flow at the cross-border will have impact on China’s solidity of financial market; alternatively will raise the anti-money laundering difficulties. Even though the global currency of a certain country will give all the destructive impacts of the country, but in the long run, the advantages of the internationalization is greatly exceeding the entire cost.

The Internationalization of the Chinese currency will not only affect internal businesses, but also affect the rest of Asia and most of the countries in the world. The policies under the RMB internationalization should be undertaken effectively to promote proper management of the exchange rates within and outside the country.

Conclusion

China’s exchange rates policies have been changed many occasions to promote the growth of country’s economy and international exchange market. Through this process, noticeable improvement of the China’s currency against United States dollar and euro has been changed consequently. China, as a developing country, should consider exchange rate instability more critically than developed countries.

Regardless of the drawbacks of some of the alternative policies which are present in China, these policies have remarkably operational and helped in promoting the development of economy and also provide security while taking loans or credit from foreign countries.

It would be wrong for China, developing country with delicate banking structure and undersized capital markets, to hold a floating method too early. This should happen only when China has stable and developed financial companies and institutions.

Increasing discussions have been observed regarding the value of RMB appreciation both in China and in global meetings. Some people have claimed that exchange rate policies would not support the intention of decreasing China’s huge trade surplus.

The exchanged rates which are present support both the importation and exportation of goods and real currency appreciation as well decrease imports to the country and hence restricts the actual effect of the policy of exchange rate on the China’s trade surplus.

Although the currency appreciation would decrease the exportation of commodities, the effect on the country’s trade surplus will be restricted hence reducing the importation of commodities. Particularly, some other country’s in East Asia, which are exporting commodities to China will fell the negatively impact of renminbi appreciation.

The policy of China’s exchange-rate is not applicable to the entire Asian countries and all the developed countries. This outcome has been seen after several Asian countries proposed that China needs have effective exchange-rate policy.

Reference List

Brigham, E & Ehrhardt, M 2010, Financial Management Theory and Practice, Cengage Learning, Boston.

Brigham, E & Ehrhardt, M 2010, Financial Management Theory and Practice, Cengage Learning, Florence, KY.

Corden, M 2009, China’s Exchange Rate Policy, Its Current Account Surplus and the Global Imbalances. The Economic Journal , vol. 114 no. 4, pp. 65-78.

Goldstein, M 2004, Adjusting China’s exchange rate policies, Institute for International Economics, Washington, DC.

Goldstein, M & Lardy, N 2009, The future of China’s exchange rate policy, Peterson Institute, Washington, DC.

Goujon, M & Guérineau, S 2007, ‘The Modification of the Chinese Exchange Rate Policy’, China Perspectives , vol. 32 no. 2, pp. 104-8.

Henning, R 2008, Accountability and oversight of US exchange rate policy, Peterson Institute, Washington, DC.

Kindler, H 2004, Exchange Rate Policy in China, Epubli, New York.

Liew, L & Wu, H 2007, The making of China’s exchange rate policy: from plan to WTO entry, Edward Elgar, London.

Modigliani, F 2009, ‘The Chinese Saving Puzzle and the Life-Cycle Hypothesis’, Journal of Economic Literature, vol. 42 no. 3, pp. 146–71.

Morris, G. (2007). ‘RMB Controversies’, Cato Journal, vol. 26 no. 3, pp. 3-20.

Obstfield, M. (2005). ‘The Mirage of Fixed Exchange Rates. Economic views Journal ‘, vol. 9 no. 6, pp. 23-31.

Rajan, R & Thangavelu, S 2009, Exchange rate, monetary and financial issues and policies in Asia, World Scientific, New York.

Soofi, A, 2008, ‘China’s exchange rate policy and the United States’ trade deficits’, Journal of Economic Studies, vol. 12 no. 4, pp. 2-34.

Wang, D, 2011, Three essays on China’s foreign exchange markets, Stanford University, Florence, KY

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IvyPanda. (2019) 'China’s Exchange Rate Policy'. 28 May.

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