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Its not World WAR I, notWorld War II

And notCold Wareither

Its

The Currency WarBy: Vivek Bhutani

IBS-Bangalore

Background

China has a fixed currency system which is alsoknown as pegged currency system. In this type of

currency system, the value of currency is fixed to the

value of another currency or basket of currencies.

Till 2005, Renminbi was pegged against US dollar at

8.28 Renminbi/USD. To keep the Renminbi at

pegged level, Chinese central bank had to supply

Renminbi and demand dollars in foreign-exchangemarkets. This pegged system created a severe

problem for US markets as US producers have to compete with Chinese cheap products due to

undervalued Renminbi. To

prevent this in US

markets, a tariff of 27.5

percent was announced

on Chinese imports until

China adjusted the value

of its currency.

In July 2005, China

announced that it would

move in the direction of a

floating exchange rate.

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As per this new policy, it still intervenes in foreign-exchange markets to prevent large and

sudden movements in the exchange rate, but it also permits gradual changes. This measure

resulted in 20% appreciation of Renminbi against USD in three years.

Since mid 2008, Renminbi barely moved against the Dollar as Chinese exporters sales overseas

had dropped sharply because of the global economic downturn. It was almost certain that

Chinese central bank returned to the policy of controlled exchange rate.

Why US is getting too much problem with Undervalued

RENMINBI?

Calamities are of two kinds: misfortunes to ourselves, and good fortune to others.

Why US is so much worried with Devaluated Renminbi? Is it because being a super power it

cant see a developing country or a so called developing country (because 2 nd largest economy

of the world with GDP of USD 10 trillion and 2nd largest US reserves holder) like China

performing really well and on its way to become a super economy? Or is it something related to

their economy.

The reason is that China has 2nd largest Dollar reserves after JAPAN. With these reserves,

China is continuously buying US treasury bonds. Bonds valuing of $889 billion which

makes China the biggest holder of US treasury bonds and the biggest creditor of US. So,

US wants the value of the Renminbi to get appreciated so that the value of US reserves

with China will fall which will bring down Chinese economy leading to release in

pressure of Debt.

Because of Chinese undervalued currency, RENMINBI against US Dollar, US current

deficit and Unemployment rate has increased. Also, Chinas cheap imports give intense

competition to US markets which results in low domestic demand of US products and

increase in demand of Chinese products.

This is not only affecting US economy but also other Asian Developing economies, as exports of

other countries have also decreased because of cheap Chinese products and their dumping

activities in other countries.

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China's undervalued currency is costing the U.S. economy more than $200 billion per year in

lost growth and is reducing American employment by as much as 1 million jobs. US Economist

Why China devaluated its currency?1. To capture the major global export market leaving behind other Asian countries.2. Devaluating currency also attracts many foreign investors which strengthens the foreign

reserves and generates more employment in China.

Due to devaluation of RENMINBI in the time of recession when global economy was struggling,

China was the only country which came out with the best figures in their Trade balance and

economic growth. The simple reason is the Undervaluing Renminbi against various currencies

like USD i.e. undervaluing 40%, Euros, Pound. This makes the exports of China cheaper. Somost of the countries prefer Chinese products against their own products resulting in Trade

Surplus for China which leads to improvement in Economic condition of China while other

countries struggle because ofhigh debt and huge trade deficit.

What can be done from both the sides?

It is better to know some of the questions than all of the answers.

If China Appreciate Renminbi

China can easily revalue its currency as it follows fixed currency system but:

If china appreciates Renminbi it will indirectly affect US economy as it will lead to inflation in US

economy and decline in the real value of household income because US population will stop

getting benefits of Cheap Chinese products as after appreciation ,Chinese products will not be

economical to the US or World economy.

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But in China it is totally opposite; savings rate in China

is much more than the consumption rate. So to trim

down the savings in Chinese economy, China needs to

privatize and deregulate large state-owned

enterprises. Chinese savings is 55% of their GDP.

Corporate savings amounts to about half of thenational savings and a major contributing factor are

the savings of Chinas State-owned enterprises which

China has to balance.

So its not only US or China who can solve the problem by themselves alone rather they have to

work on their respective economies and should balance the structure of savings and

consumption so that US as well as China can come out of trade imbalance in their economy.