The escalation of the trade war, sparked by fresh US tariff threats , is seen to have prompted the policy shift. On Monday, the People's Bank of China PBOC said the slump in the yuan was driven by "unilateralism and trade protectionism measures and the imposition of tariff increases on China". The yuan is not freely traded and the government limits its movement against the US dollar.
Unlike other central banks, the PBOC is not independent and faces claims of interference when big moves occur in its value. Capital Economics Senior China Economist Julian Evans-Pritchard said by linking the yuan's devaluation to the latest tariff threats, the PBOC has "effectively weaponised the exchange rate, even if it is not proactively weakening the currency with direct intervention".
A weaker yuan makes Chinese exports more competitive, or cheaper to buy with foreign currencies. From the US perspective, it is seen as an attempt to offset the impact of higher tariffs on Chinese imports coming into America.
While it appears a win for consumers around the world - who can now buy Chinese products more cheaply - it carries other risks. A weaker yuan will also make imports into China more expensive, potentially driving up inflation and creating strains in its already slowing economy , as well as pushing currency holders to invest in other assets. Back in , China's central bank pushed its currency to its lowest rate against the US dollar in three years, in part to deal with easing growth.
China's investment as a percent of GDP rose to China's private consumption as a percent of GDP dropped from Chinese private consumption as a percent of GDP was Although private consumption has been a much smaller share of China's GDP than other countries, the growth rate of China's private consumption has been significant.
From to , Chinese private consumption grew at an average annual rate of 8. Many analysts contend that, although Chinese labor productivity has risen rapidly over the past several years, workers' wages have not kept pace with those productivity gains, largely due to the lack of worker rights in China, especially for migrant workers who tend to seek work in labor-intensive, export oriented, manufacturing.
Rather, it is argued, the gains from productivity have largely accrued to Chinese firms. Most choose to deposit their savings in a Chinese bank. However, bank interest rates are set by the central government, and oftentimes, the rates of return on savings deposits are below the rate of inflation see Figure A Chinese depositors faced negative real interest rates in , , , , and Many economists contend that this policy represents an effort by the central government to keep the cost of credit low for Chinese firms in order to boost fixed investment , but that this comes at the expense of Chinese households whose savings deposits can actually lose value, thus forcing them to save more of their income to cover the costs of health care, retirement, and other large expenses.
That rate fell to Many economists contend that the goal of rebalancing the Chinese economy toward greater reliance on personal consumption cannot be achieved until the central government eliminates distortive economic policies that favor firms over households.
Once such policy relates to the government's control over much of the country's banking system. Chinese Real Deposit Interest Rates: Notes: Interest rates on one-year deposits adjusted for changes in the consumer price index. Gross fixed investment some of which is linked to tradable sectors was the largest contributor to its real GDP growth over much of this period. In , changes to net exports in China were a drag on the Chinese economy, while in they provided a modest contribution to GDP growth.
In , private consumption was the largest contributor to China's GDP growth. The next few years could be a critical period for China's economic policymakers. A number of economists have questioned the quality of China's massive investment efforts over the past two years and the ability of local government to repay the loans they took out to fund major investment projects.
Thus, the importance of fixed investment to China's economic growth over the next few years could decline. The Chinese government's 12 th Five Year Plan states that rebalancing the economy, promoting consumer demand, boosting rural incomes, addressing income disparity such as boosting wages , promoting the development of the services sector, and expanding social welfare programs such as education, social security, and health care will be major priorities.
Such policies, if implemented, could provide a significant boost to consumer spending. Based on China's historical economic model, it will likely take several years for a significant rebalancing of the Chinese economy to occur. In addition, many economists have raised concerns that, as China's major trading partners, such as the United States and Europe, begin to experience more rapid economic growth, their demand for Chinese products will increase, which could discourage China's government from following through on economic reforms necessary to promote a rebalancing of the economy.
The official name of China's currency is the renminbi RMB , which is denominated in yuan units. Both RMB and yuan are used interchangeably to describe China's currency. These were government-sanctioned foreign exchange adjustment centers established in to allow a limited amount of trade in foreign exchange, although the central government intervened to prevent the RMB from strengthening beyond 6 yuan per dollar.
Source: U. Overseas investment by Chinese citizens is tightly regulated and restricted by the central government. For example, it would be very difficult for a Chinese citizen to open a savings account in another country or invest in shares of foreign stocks without permission from the government. Limiting capital outflows from China is a key policy tool of the central government to control exchange rates within China.
In addition, some analysts contend that China fears that an open capital account would lead to capital flight, which could undermine its financial system. It was later announced that the composition of the basket would include the dollar, the yen, the euro, and a few other currencies, although the currency composition of the basket has never been revealed. If the value of the yuan were determined according to a basket of currencies, however, it would not have shown the stability it has had against the dollar between mid and mid, unless the basket were overwhelmingly weighted toward dollars.
The fact that the currency has appreciated some days but has depreciated on others raises a number of questions as to the extent and pace the PBC will allow the RMB to appreciate over time. Many observers believe that this is a sign that appreciation of the RMB will happen over a long period of time, but in an unpredictable way in an effort to limit RMB speculation and inflows of "hot money," which could destabilize China's economy.
A trade-weighted index reflects the relative importance of each partner's trade with China. The index itself is calculated as the geometric weighted averages of bilateral exchange rates. Thus the dollar accounts for a significant portion of the index—it averaged 19 points out of from to , while the euro averaged In general, U. China emerged as the world's largest merchandise exporter in accounting for These rankings have stayed constant through The current account balance is the broadest measurement of trade flows because it includes trade in goods and services.
It also includes income flows and current transfer payments. China's accumulation of foreign exchange reserves in the first quarter of was 3. Note, the IMF's July estimates of China's current account surpluses as a percent of GDP in and were different than the estimates it made in April at 2. Fred Bergsten and Joseph E. Gagnon, December Scott, August 23, Note, some have criticized the methodology used in the report, which assumes that the U.
New York Times, December 31, Krugman also estimated that China's currency policy caused 1. Many members sharply criticized the Department of the Treasury's decision in April to delay issuing its first exchange rate report usually issued in March or April. That report was issued on July 8, after China made its announcement on currency reform , and it did not cite China or any other country for currency manipulation.
Testimony by C. Of particular concern to some groups are proposals that would require the U. A September 22, , letter sent by a group of U. A number of U. Some petitioners have argued that when Chinese exporters are paid in dollars and subsequently exchange those dollars for Chinese RMB, the payment RMB they receive is larger than would occur under market conditions because of the Chinese government's intervention to keep the RMB artificially low against dollar.
This policy is viewed as constituting a financial contribution or price support. The Commerce Department has yet to include an undervalued currency as part of its countervailing duty investigation. In one case involving imported aluminum extrusions from China, which included a charge by petitioners that China's undervalued currency was a countervailable subsidy, the Commerce Department stated that additional study of the issue was needed, given the unique nature of the alleged subsidy and the complex methodological issues that it raises under U.
The benefit would be defined as the difference between the amount of foreign currency received by the exporter from the transaction and the amount that would have been received if the currency was not undervalued. In other words, the undervalued currency could be considered to be a measure that is contingent upon export performance. Real effective exchange rates are defined as a weighted average of bilateral exchange rates, adjusted for inflation.
Under U. In such cases, Commerce uses price information from "surrogate countries" that have a market economy to determine the normal value of the imported products in question. Some analysts contend that this practice results in higher antidumping rates on imports from nonmarket economy countries than on those from market economy countries. Takatoshi Kato , September 30, China's currency issue was also a major topic under the U. The multilateral approach may also act as an inducement for China to reform its currency policies.
If other economies especially Asia agree not to intervene in currency markets to prevent their currencies from appreciating or depreciate them to gain a competitive edge against Chinese exporters , China might agree to quicken the pace of currency appreciation and reform. If China went ahead and appreciated its currency, other Asian economies might do the same.
This might help minimize Chinese concerns that an appreciating currency would disrupt its export sector. This is often referred to as the real or equilibrium exchange rate and is broadly based on assumptions of what exchange rates would be predicted to be in order to be consistent with a country's fundamental macroeconomic conditions.
Cline, William R. The ERER approach estimates an equilibrium real exchange rate for each country as a function of medium-term fundamentals, such as the net foreign asset NFA position of the country, relative productivity differential between the tradable and non-tradable sectors, and the terms of trade. The ES approach calculates the difference between the actual current account balance and the balance that would stabilize the NFA position of the country at some benchmark level.
The MB approach calculates the difference between the current account balance projected over the medium term at prevailing exchange rates and an estimated equilibrium current account balance, or "CA norm. The semi-annual series of estimates of FEERs was coauthored with [author name scrubbed] until his retirement. House of Representatives, March 24, Some analysts contend that U. Trade varied from year to year.
In , U. The current global economic slowdown led to a sharp reduction in U. As a result, the U. Depending on the elasticity of demand for the product, some might be willing to pay the extra price and buy the same level as before, some might buy less of the product, and some might stop purchasing the product altogether.
Some of the costs may have been borne by Chinese producers or workers. Alternatively, China might have been able to boost efficiency, thus lowering costs, or production could have moved inland where labor is less expensive. The Case of Apple's iPod , March He also argues that reducing the federal budget deficit in the long run is the best way to boost employment and states that "in comparative importance, the value of the RMB is a footnote.
Bureau of Economic Analysis, personal consumption expenditures is the primary measure of consumer spending on goods and services in the U. See U. The standard economic model for determining whether countries should have a floating exchange rate is the "optimal currency area" model. According to this model, two countries can gain from fixed exchange rates if their goods and labor markets are highly interconnected and their business cycles are closely synchronized.
By these criteria, China and the United States are unlikely to form an optimal currency area. Many such firms contend that China's currency policy constitutes one of several unfair trade advantages enjoyed by Chinese firms, including low wages, lack of enforcement of safety and environmental standards, selling below cost dumping and direct assistance from the Chinese government. This trend is much larger than the Chinese currency issue and is caused by numerous other factors, including productivity gains in manufacturing such as through new technologies and the rise of employment in the service sector.
From to , China's holdings of U. China has expressed concern in recent years over the "safety" of its large holdings of U. It has criticized the U. Federal Reserve's easy monetary policies to boost economic growth, such as quantitative easing involving large-scale purchases of U. Treasury Securities. Chinese officials claim that such policies could lead to a sharp devaluation of the dollar against global currencies and boost U. Fair, Ray C. There have been numerous reports of labor unrest and strikes in different parts of China in , mainly over pay issues.
Chinese officials are concerned that an appreciation of the RMB could induce Chinese export producers to try to hold down wages to remain competitive, or could force them out of business, which could lead to more job losses and provoke more unrest.
Some recent media reports indicate that data on the level of Chinese exports in may be overstated because some entities in China may be filing fake export invoices in order to transfer capital to China. The ultimate goal of trade is to obtain imports in exchange for exports. The more imports a country can obtain from a given level of exports, the better off it is materially.
China appears to be willing to "subsidize' its exports in order to boost jobs in export-oriented industries.
However, Chinese consumers are made worse off. The government can and has attempted to sterilize the increase of the money supply by forcing state banks to buy and hold government bonds. Some economists argue that short-term movements in floating exchange rates cannot always be explained by economic fundamentals. If this were the case, then the floating exchange rate could become inexplicably overvalued undervalued at times, reducing increasing the output of U.
These economists often favor fixed or managed exchange rates to prevent these unexplainable fluctuations, which they argue are detrimental to U. Other economists argue that movements in floating exchange rates are rational, and therefore lead to economically efficient outcomes.
They doubt that governments are better equipped to identify currency imbalances than market professionals. Alternatively, if Chinese citizens proved unconcerned about keeping their wealth in Chinese assets, the removal of capital controls could lead to a greater inflow of foreign capital since foreigners would be less concerned about being unable to access their Chinese investments.
This would cause the exchange rate to appreciate. To some extent, China can reduce the effects of the accumulation of foreign reserves on the money supply through credit controls, although this is unlikely to be completely effective.
Others in Congress, however, continue to view the large and growing U. Department of the Treasury press release, Third Meeting of the U. The current account balance is the broadest measurement of a country's financial flows. It includes the balances for trade in goods and services, net income investment income and compensation for overseas workers , and net unilateral transfers.
A current account deficit also reflects that a country consumes more than it produces, while a current account surplus indicates that a country produces more than it consumes. China's current account surplus as a percent of GDP fell each year from to Gross private savings as a percent of GDP rose from Source: Bureau of Economic Analysis.
This is not to say that Chinese wages have not gone up in recent years. Source: EIU. Chinese house consumption is also repressed because of the lack of an adequate social safety net. This forces them to maintain a high rate of savings in order to pay for medical costs, education, and future retirement costs if they don't have a pension.
Topic Areas About Donate. Further tests are coming for the yuan ahead of the U. And in May this year, it edged closer to a decade-low after the Trump administration stepped up rhetoric against Beijing over its handling of the coronavirus. Analysts expect the exchange rate to end the year 0.
Never miss a story! Stay connected and informed with Mint. Download our App Now!! Over the past 20 years, the yuan had been appreciating relative to nearly every other major currency, including the U. However, China's economy had slowed significantly in the years before the devaluation.
On the other hand, the U. Understanding the market fundamentals clarifies that the small devaluation by the PBOC was a necessary adjustment rather than a beggar-thy-neighbor manipulation of the exchange rate. While many American politicians grumbled, China was actually doing what the U. While the drop in the yuan's value was the largest in two decades, the currency remained stronger than it had been in the previous year in trade-weighted terms.
Currency devaluation is nothing new. From the European Union to developing nations, many countries have devalued their currency periodically to help cushion their economies. However, China's devaluations could be problematic for the global economy. With Chinese goods becoming cheaper, many small- to medium-sized export-driven economies could see reduced trade revenues.
If these nations are debt-ridden and have a heavy dependence on exports, their economies could suffer. For instance, Vietnam, Bangladesh, and Indonesia greatly rely on their footwear and textile exports. These countries could suffer if China's devaluations make its goods cheaper in the global marketplace.
For the Indian economy , a weaker Chinese currency had several implications. As a result of China's decision to let the yuan fall against the dollar, demand for dollars surged worldwide.
That included India, where investors bought into the greenback's safety at the expense of the rupee. The Indian currency immediately plunged to a two-year low against the dollar and remained low throughout the latter half of The threat of greater emerging market risk due to the yuan devaluation led to increased volatility in Indian bond markets, which triggered further weakness for the rupee.
Usually, a declining rupee would aid domestic Indian manufacturers by making their products more affordable for international buyers. However, in the context of a weaker yuan and slowing demand in China, a more competitive rupee is unlikely to offset weaker demand going forward. Additionally, China and India compete in several industries, including textiles, apparel, chemicals, and metals.
A weaker yuan meant more competition and lower margins for Indian exporters. It also meant that Chinese producers could dump goods into the Indian market, thereby undercutting domestic manufacturers. India had already seen its trade deficit with China nearly double between to and to On the flip side, falling commodity prices made it much more difficult for Indian producers to remain competitive.
The Chinese yuan generally depreciated against the U. Treasury Department officially named China a currency manipulator on August 5, It was the first time the U. However, the U. According to then-U.
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