**This was an article that was originally posted Feb. 27, 2007 and resurrected today in light of the news the US is increasing pressure on China to revaluate their currency. To learn more about revalution check out our devaluation and revaluation article.***
US politicians and lawmakers are pushing hard for China to revaluate their currency. Why is this important? By revaluating China essentially will force their currency to appreciate. Once that happens their goods become comparatively more expensive to purchase. The economy in China will slow as less countries demand their products. For China this is undesirable if they have the demand to continue their breakneck expansion. On the flip side, it will help America address their trade deficit woes.
But then again, the US has threatened before and nothing has happened, maybe because their economy clout is gone and China is now the powerhouse? I don’t think it’s quite at that level, so maybe this time we’ll see some fireworks….
Here’s what we posted about this situation three years ago, so there’s not indication that these latest threats will do any good…..
Is the honeymoon over? Have countless opportunities to revaluate the currency left China vulnerable? China’s stock market suffered its biggest single-day drop in more than 10 years on Tuesday, sending resource stocks in Toronto falling sharply in morning trading.
The Shanghai Composite Index fell almost 9 per cent to close at 2,771.79 — its largest single-day decline since it fell 9.4 per cent on Feb. 18, 1997 after the death of Communist party elder Deng Xiaoping.
The drop is attributed to profit-taking and speculation of a fresh round of austerity measures from the Chinese government to slow sizzling economic growth.
The Toronto stock market fell more than 200 points early Tuesday morning, as investors worried that the plunge in China could also mean a sharp drop in demand for metals and oil.
Economic data also weighed on the markets. U.S. orders to factories for big-ticket manufactured goods plunged in January by the largest amount in three months.
[tags]china economy, china bubble, china’s foreign exchange, china revaluation[/tags]
It will be interesting to see if the Chinese government will actually be willing to revaluate their currency. To do so would immediately cause their economy to plummet, especially in the short run. Will they finally be willing to accept some short term instability and possible political unrest for a long term stability? Time will tell.
If they do float their currency to a greater extent, it could be a game changer. This would mean that they would likely not need to purchase as many US dollars which could mean an increase in our interest rates. These will be interesting times.
If I understand the system right, the Chinese keep the USD rate stable (in reality near fixed in light of the recent relaxation) simply by not selling the dollars they receive for their exported goods, instead holding the USD, which explains why they’ve come to hold i-don’t-know-how-many trillions of US Treasury bills.
If the Chinese let the RMB rise, it just means they are selling more of their earned dollars (probably funded from trading, not biting into their existing stock-pile), meaning the value of USD they would still hold would fall at market prices (in RMB) so the PRC would have made a paper loss, of sorts. This hurts no Chinese individuals or companies, just the country’s treasury I suppose, so no harm no foul.
The Chinese individuals and companies would be holding more valuable RMB, so they would have done well (except they can’t sell the currency, so it’s a little meaningless). They would of course find their exports a little more expensive, and imports (oil & materials) cheaper, so maybe there would be more incentive or domestic consumer spending, further encouraged by the suggested pay inflation rate of c.30% in the citie of China since lunar new year.
Key point seems to be that the PRC have been supplying goods on credit to us in the west for years. At some point they are going to want to cash those cheques, but I don’t think that point will come until the PRC government decide they want to spark domestic consumption, and I don’t think we’re there yet.
A simple explanation is to point out what happens to US dollars. How do you just ‘buy’ dollars. You could buy reserves, but you have to get it from somewhere. One way is to purchase US Bonds. China owns a lot of US debt. In a sense they are propping up the strength of the dollar by buying up these assets. If they were to liquidate it would increase the supply of USD in the global market thus making the USD less valuable. That would mean US purchasing power decreases–they basically have to pay more for stuff.
Now the flip side, because there’s always one, is China revaluates and they end up paying LESS for goods abroad (revaluate means your currency appreciates thus you can increase imports). But of course we know that China exports more than imports. So if their goods are more expensive people will stop buying them. In this case you’ll find the main argument of Chinese goods–they’ll be more expensive and money will stay in the US.
Of course, the whole system is dependent on prices. It’s a catch 22, Yankees love their cheap walmart crap and won’t pay for more even if it means importing from china over Delaware 😛
China is thought to be overheated and at an expansion pace they can’t support. But think of it, you show a billion Chinese who live with significantly less a day than Americans a catalogue to buy stuff, you’ll find that there’s untapped potential within China to support their economy……….. We’ll see if the latest changes will do anything on the world stage.
China has confirmed by the way that they’re releasing their floating rate to the USD.