Their low cost productions have made China favorable for foreign company to produce goods for export. However, due to excessive buying and selling of US dollar, US is suffering from an increasing trade deficit. The manufacturing companies in US cannot compete with Chinese imports due to the relatively low product cost. Many of them become Jobless. The US government tried to persuade China into using a more flexible exchange rate policy to increase the Yuan currency. In year 2005, the china government finally bowed to the pressure and they have taken a more flexible exchange rate policy.
The Yuan was allowed to move at a certain percentage each day against other currencies. The US government will place a higher tariff on Chinese imports if they are not depreciated further against the dollar. Question 1 Why do you think the Chinese government originally pegged the value of the Yuan against the U. S. dollar? What were the benefits of doing this for China? What were the costs? The Chinese government pegged the Yuan currency against the U. S to control the value of its currency. By doing so, China keeps its Yuan value lower than the U. S. alue. Furthermore, China originally pegged its Yuan value against U. S. s the U. S. dollar is considered as highly reliable financial instrument in the global market. In order for the country to become an export driven economy, the undervalued Yuan will attract more exports from foreign country. The china government also believed that a fixed and stable currency is crucial for the development and growth of the industry. There are many benefits China gained from holding its currency to foreign market. They gain competitive advantage with their low currency.
As Yuan currency is undervalued by almost 40%, their exports will be less expensive making it favorable for the foreign company to invest. With this advantage, the profit seeking companies are attracted to invest in China as they have cheap labor and raw material. In addition, due to the government using managed float policy, the currency value is not affected by supply and demand of a given currency. Therefore, the country will not easily get affected with economic fluctuations as the government regularly buy or sell its currency to influence its short term exchange rate.
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This condition is ideal to encourage investment as it reduces fluctuations and risk. Fixed exchange rates enable firms to make decisions and plan ahead. All of these will help o boost china growth and development. There are disadvantages of using this strategy to both China and U. S. In order for china to maintain its currency as low as Due to excessive export, the country also may face the risk of natural resources depletion. Since China holds most of the global manufacturing, they might use up all the country natural resources in the long run. The U. S also faces a trade deficit as its imports are greater than exports.
In addition, the trade deficit is also caused by large amount of U. S dollar being held by foreign nation. A greater trade deficit is unhealthy for the economy as it can lower the currency. Since production cost in China is cheaper, many local manufacturing companies in U. S suffer as it cannot match with the low price offered by china. This causes many U. S manufacturing companies to shut down or lay off workers to cover their expenses. Question 2 Over the last decade, many foreign firms have invested in China and used their Chinese factories to produce goods for exports.
If the Yuan is allowed to float freely against the US dollar on the foreign exchange markets and appreciates in value, how might this affect the fortunes of those enterprises? If Yuan is allowed to float freely, the currency will appreciate. As the Yuan strengthens, the foreign firms that invested in china and used china as its manufacturing factory based will not gain any benefits on this. Most of the company invested in china because of its stable and relatively cheap currency in order to skim maximum revenues. China, which is favored by its low cost labor, will no longer be made possible if the Yuan currency increases.
When the Yuan currency increases, the cost of material, labor and export will increase. Therefore, the production cost will be higher. The foreign company might not be able to sell its product at their usual price and it will affect the company profit margin. They might have to increase the price of the product in order to get the same profit. The increase in price of the product will not please the customers. It will cause a decrease in demand for china made product as they are known to produce goods at lower prices. The customer might shift its preferences with other cheaper substitute.
This is not good for the company as it reduces sales and can affect their investment. Mattel for example, which is famous for its Barbie doll brand, outsources nearly 70% of its toy production from China. However, if the Yuan increases, it would result in an increase in the U. S dollar. Therefore, the profit margin for Mattel will fall as it has increase in product cost. However, the increase of Yuan currency also raises the Chinese standard of living. The Chinese gain more purchasing power and foreign company can direct its sales towards china market.
The company can earn higher profit due to China large population as a substitute for the export market. The foreign company seeking for a lower product cost will have to shift its production to other low cost country in order to maintain its profit. Question 3 How might a decision to let the yuan float freely affect future foreign direct investment flows into China? By letting the Yuan float freely, China will become richer. Besides that, it could increase the foreign direct investment too. This will increase the Chinese economy and Chinese people's purchasing power.
Foreign investor will take advantage of the growing China economy because of the higher buying power. Besides that, a freely floating Yuan would result to currency appreciation and significant decrease in the demand for Chinese exports. The people who make money of Yuan increased the value of their properties in China increased. If China were to abandon its peg, that could result in a slowdown in its exports. Question 4 Under what circumstances might a decision to let the yuan float freely destabilize the Chinese economy? What might the global implications of this be?
A freely floating Yuan can increase the value of China's currency and lower the demand for export. Lower demand for export could mean lower Jobs available and thus higher unemployment. Higher unemployment can lead to domestic unrest and if not controlled to economic destabilization. The idea of keeping Yuan low in value on the global market is for other countries to buy China's exports. This will boost the China's economy. If China no longer provide for the world, all of the other countrys economies will suffer. If Yuan is allowed to float, China will see some of its manufacturing slow as companies lose the benefit of cheap Yuan exports.
A stronger Yuan would give the Chinese more buying power, which might benefit foreign investors. If the raise of Chinese Yuan will push up inflation, China makes everything and not only supplies to US, but all over the world. Raise of Chinese Yuan means raising everyone's living cost in a chain Just as the cell phone wire that make in China gets more expensive, your phone cost more, the pizza store who uses phone a lot ncrease the fee of pizza. It will only give a big inflation to all of us (people lives in US. ). Now, people in US are more in demand of low-budget products.
Question 5 Do you think the U. S. government should push the Chinese to let the yuan float freely? Why? Chinese legislature basically pegged the worth of the Yuan against the US dollar as an endeavour to rival the US and whatever is left of the world. US dollar was the strongest in the worldwide business. The profits for China were that their Yuan might stay week. Their fares might remain modest while their economy thrived on preparation for the US economy. The expenses for China were that they needed to trade for US dollars each month and that their trade was the US shortage.
The US dollars development will influence the China's economy either way. The US legislature shouldn't prod the Chinese to let the Yuan float openly. Depending on if the Yuan float unreservedly, it was able to build regulate backing streams into China. An unlimited rushing Yuan makes China wealthier. This will support the Chinese economy and make the Chinese individuals' acquiring power higher. Due to, the higher getting power, different investors will look to profit from the developing Chinese economy (unique87, 2010). Question 6 What do you think the Chinese government should do?
Let the yuan float, maintain the peg, or change the peg in some way? In 1996 Chinese money got convertible yet strict controls made it challenging to clandestine the Yuan to different coinage and between 1994 and 2005. To keep the Yuan from climbing against the dollar the midway bank purchases a large portion of the different money that streams into the nation from fares and outside transaction from the nation's business banks and trade them to Yuan. To avert the aforementioned finances from dropping in the oney related framework and fuelling swelling, the centremost bank issues treasury bills to money related foundations.
In 1994, China cut the Yuan's worth by 30 for every penny and received a maintained buoy framework. In 1997, throughout the Asian fiscal emergency, the Yuan was pegged to the U. S. dollar. The conversion scale for the yuan was 7. 97 in 2006, 8. 19 in 2005, and 8. 27 in 2002, 2003 and 2004. Numerous exiles need to see the Yuan buoy, with the intention that it reflects its correct esteem and makes Chinese merchandise and labour more costly. They contend the flat Yuan gives Chinese endeavours a crooked point of interest and akes it hard for makers in different nations”unable to match the level costs of Chinese imports”to contend.
The U. S. Secretary of the Treasury has flown out to Beijing particularly to score concessions on this issue yet has Just been given bewildering guarantees that the Yuan will be permitted to buoy openly at a certain time sometime later. The quality of the Yuan is situated by the State Council not the mid bank. The Chinese legislature is agonized over authorizing the development of money crosswise over fringes, fuelling theory blast like the kind that accelerate Asian nvestment emergency in 1997.
It additionally contends it ought to gets in banks in place before it can permit the Yuan to buoy; it ought to uphold development to balance work misfortunes in the state-claimed ventures; and coin soundness profits not Just China however each nation that exchanges with China. In April 2006, the Chinese administration issued regulations that made it simpler for Chinese to contribute abroad and Chinese associations to purchase remote trade. The move was needed to create more surge of strange money and diminish upward force on the Yuan (Hays, 2012).
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