Thursday, July 21, 2005

China Un-Pegs The Yuan

If you haven't heard, China has abandoned their decade-old currency peg against the dollar. The yuan (Chinese currency) has since appreciated about 2.1% which many economists claim to be a small rise. So what does this mean for the U.S?

Some say that the dollar will lose value relative to other major currencies and as China stops investing in our debt, interest rates will rise. Rising interest rates means bad news for the housing market- and according to Paul Krugman's latest column, "maybe very bad news, if the interest rate rise burst the bubble."

If you want to hear more about this, here is a Wall Street Journal econblog.


Blogger Jim V said...

What does it mean to "peg" currency? Sorry if it's a dumb question.

6:17 AM  
Blogger David Yaffe said...

It is a currency that uses a fixed exchange rate as its "exhange rate regime"(the way a country manages its currecy in respect to other currencies). If the yuan is pegged to the dollar, then the yuan value is matched to the value of the U.S dollar. As the dollar rises and falls, so does the yuan.

10:58 AM  
Anonymous NICK said...

I read the AP article by Crutsinger and found the analysis quite fluffed. First of all, inflation right now is already at a 6 month average of 2.99, which is only 2.9 by government think tank calculations. Anyway, this article said that most economists see this as a good thing for the American economy. The first question I asked was why? Then how? Well, at the end of the article Crutsinger said, "as American products become cheaper in China, U.S. exports will increase and rising prices for Chinese goods will cause Americans to curb their own purchases eventually." America has "a record $162 billion deficit with China" right now. In layman's terms, that simply means that we've borrowed $162 billion from China to cover our government's excessive spending. If the new exchange rate will make American rely less on Chinese imports, then, yes, we will see the deficit go down. But exactly what will we substitute for these goods? Is this implying that America will "curb" its excessive consumption? What do you think Judge Yaffe?

11:29 AM  
Blogger David Yaffe said...

Ok, good question. In Krugman's column, he says,
"An end to China's dollar-buying spree would lead to a sharp rise in the value of the yuan. It would probably also lead to a sharp fall in the value of the dollar relative to other major currencies, like the yen and the euro, which the Chinese haven't been buying on the same scale. This would help U.S. manufacturers by raising their competitors' costs."

At first I didn't understand this. So I got some help from one of my professors, Mark Thoma. When the yuan appreciates (which it has already), Chinese exports become more expensive, and its export should fall. When the U.S dollar depreciates, U.S. exports become cheaper to other countries and exports should rise. Both these effects are good for U.S manufacturers. Thoma says further, "The second part is that China imports a lot of its raw materials. These will get cheaper offsetting some of the disadvantage from appreciation of the yuan, but on net it should cause Chinese goods to become more expensive and therefore reduce U.S. imports of them. This helps U.S. manufacturers since Chinese goods are more expensive in the U.S."

Now the U.S. can rely on their own manufacturers to supply their demands. Furthermore, now that we can expect the dollar to depreciate, countries will import more U.S. goods. This is a good thing that may "offset" some negative effects. What kind of effect a depreciation will have on the domestic front is still up in the air, but you heard what Krugman said.

Hope this helps.

12:08 PM  
Blogger David Yaffe said...

I should mention that as of now, nothing has changed since the unpegging of the yuan to the dollar. Perhaps this is a beginning, but nothing has changed yet that will significantly change the accumulation of US foreign debt.

12:40 PM  

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