Pegging the Yuan
The decision to peg the yuan to the US dollar at a fixed rate was driven by some significant economic benefits. First of all, the role in this decision was played by the fact that it could increase stability and control over the economy. China is constantly undergoing economic reform, which creates complex processes that are crucial to manage (Das, 2019).
The gradual shift from a centralized economy to a market-oriented one requires foreign investment, which is attracted by the creation of a stable exchange rate. This made the yuan more competitive in the international market, which contributed to the increase in Chinese exports to foreign markets (Belon, 2022). Thus, the main advantages were the active injection of foreign capital and the opening of trade markets. However, this came at a cost to the country, creating trade imbalances with the United States and leading to accusations and political tension.
Investments of Foreign Companies
The impact of the free price of the yuan for foreign companies investing their financial resources in China will depend primarily on exchange rate fluctuations. In addition, a significant aspect is the competitiveness of companies’ products and their hedging strategies. For many organizations exporting their products from China, the free exchange rate of the yuan against the US dollar can create financial risks.
If the yuan declines significantly, it could erode profits; conversely, if the dollar falls relative to the yuan, this will have a positive impact on the profits received (Fofanah, 2020). In addition, with the strengthening of the Chinese currency, which is not pegged to the US dollar, the goods of Chinese companies may become significantly more expensive, reducing demand for them from foreign buyers.
The Future of Foreign Investment Flows
The free exchange rate of the yuan may heavily influence future flows of foreign investment into China. The first necessary consequence may be an increase in investment flows, as China will become more attractive from the investors’ perspective (Lu et al., 2019). Fluctuations in the market exchange rate can simultaneously increase transaction transparency, which has a positive impact on the emergence of additional incentives for foreign investment.
In many ways, foreign investment is influenced by the hedging strategy that companies adopt (Li et al., 2021). In the context of a constantly changing yuan exchange rate, this will become one of the primary strategies for organizations investing in China. Industries that rely heavily on exports may become less attractive to external investors, but those in which the domestic product is more important will begin to develop more strongly.
Destabilization of the Chinese Economy
A decision to float the RMB could destabilize the Chinese economy if there is excessive exchange rate volatility. If a national currency experiences sharp and rapid fluctuations, it can disrupt economic planning, which is crucial for international trade and partnerships. Additionally, the global consequences could include disruptions in supply chains that would occur if the yuan were to depreciate (Bahmani-Oskooee et al., 2023).
This, in turn, could lead to trade tensions that exacerbate the situation in the political arena. Other countries may accuse China of currency manipulation, which could result in unfair gains in international sales (Huang & Luk, 2020). Thus, the global consequence will be that relations with China will be strained for many countries, and international trade will be disrupted from its usual flow.
Pressure on China
US pressure on the Chinese government regarding the yuan peg may have some adverse effects. Because of this, I believe that the US government should not interfere with Chinese market regulation. One of the consequences of such an action could be a negative attitude towards America among the Chinese, which would exacerbate the already tense relations (Das, 2019).
Thus, by interfering in the affairs of a sovereign state, the United States will not achieve the desired result but can worsen international relations with China. This could also pose a threat to global stability, as sudden changes in China’s economy could disrupt the global economy. US pressure on a large economy like China’s could develop into political tensions and impact business opportunities.
Future Actions
Determining the future course of action regarding the RMB exchange rate is a complex process that requires careful consideration. In my opinion, the Chinese government should maintain a fixed exchange rate to achieve economic stability and ensure that all parties are satisfied. In addition, this approach, which China has adopted for a considerable time, enables the effective development of an export system that currently has a significant impact on all countries worldwide, including the United States (Lin et al., 2020).
In view of these factors, a fixed exchange rate can reliably fulfill its functions of supporting an export-oriented economy (Vochozka & Vrbka, 2019). In addition, changes could lead to severe volatility, which would be devastating for investors and many companies. This will harm all sectors of the country that depend on exports, as this category is expected to decrease significantly due to constant exchange rate fluctuations.
References
Bahmani-Oskooee, M., Usman, A., & Ullah, S. (2023). Asymmetric impact of exchange rate volatility on commodity trade between Pakistan and China. Global Business Review, 24(3), 510-534.
Belon, S. (2022). Alleged Chinese Currency manipulation: the case of Yuan in relation to the USD from 2005 to 2020 [Bachelor’s Thesis, Institute of Economic Studies].
Das, M. S. (2019). China’s evolving exchange rate regime. International Monetary Fund.
Fofanah, P. (2020). Effects of exchange rate volatility on trade: Evidence from West Africa. Journal of Economics and Behavioral Studies, 12(3 (J)), 32-52.
Huang, Y., & Luk, P. (2020). Measuring economic policy uncertainty in China. China Economic Review, 59, 101367.
Li, L., Tao, L., Li, Q., & Hu, Y. (2021). Experimentally economic analysis of ORC power plant with low-temperature waste heat recovery. International Journal of Low-Carbon Technologies, 16(1), 35-44.
Lin, K. J., Lu, X., Zhang, J., & Zheng, Y. (2020). State-owned enterprises in China: A review of 40 years of research and practice. China Journal of Accounting Research, 13(1), 31-55.
Lu, Y., Wang, J., & Zhu, L. (2019). Place-based policies, creation, and agglomeration economies: Evidence from China’s economic zone program. American Economic Journal: Economic Policy, 11(3), 325-360.
Vochozka, M., & Vrbka, J. (2019). Estimation of the development of the Euro to Chinese Yuan exchange rate using artificial neural networks. In SHS Web of Conferences (Vol. 61, p. 01030). EDP Sciences.