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This was an interesting article in Business Week. The article discusses the influence of China in bringing the prices of manufactured goods down in the global market.
In the past few years, there have been reasons for the Chinese yuan to go down, and reasons for it to go up. Some of the countries including South Korea, Thailand, Indonesia and Russia had all suffered severe currency crashes, which was a huge set-back for the Chinese export manufacturers. They experienced fierce competition from these countries and requested the Chinese government to reduce the value of yuan.
In a few years after the Chinese government fixed the value of yuan, Chinese manufacturers were flooding the world market with cheap goods in almost all industrial sectors. This caused panic among other countries as they noticed that the Chinese prices were becoming global prices and feared that it would be difficult to bring robust/free-market pricing to these sectors. As a result, these countries, including the trading partners of China started putting pressure on China to make the yuan appreciate.
We have studied the impact of inflation on exchange rates. It is also equaly important to understand the impact of deflation. During deflation, the prices of domestic goods and services go down, making foreign imports less attractive. As a result, less currency is supplied to the foreign exchange and the value of currency eventually goes up.
China is one of the few remaining countries to fix its currency’s exchange rate rather than let it sell at the free market (supply & demand) equilibrium value. Having a fixed exchange rate for the yuan, Chinese exporting manufacturers are much more competitive in global markets. Even with other favorable conditions, other countries find it hard to compete against Chinese exporters who have the benefit of a pegged yuan. These countries are also worried about the pricing trend set by China, which they fear would become the global prices in all the industrial sectors. These prices cause imbalances in the developing world. Industries and service sectors in other countries had started plunging because of a pegged yuan. Hence, other countries are keeping a close watch on China’s exchange rate policy, trying to let the Chinese government float the yuan at free-market rates.
Letting the currency to float is expected to increase the value of yuan which makes China’s exports more expensive and less competitive in world markets. This would drop China’s exports, and as a result, would wipe out the weakest producers and hammer the banking sector. As a result, unemployment rates would sky rocket. Hence China would leave its exchange rate exactly where it is.
Chinese banks are holding a lot of bad debt and many are technically insolvent (liabilities exceed assets). This bad debt can cause a decline in China’s growth and less currency available in the world market. The decline in growth also leads to deflation. As a result, the value of yuan could go up.
This was an article from BusinessWeek Online. The article compares currency fluctuations with Christmas morning because exporters have waited such a long time for the dollar to fall. (The dollar was high from 1995-2002.) Now they’re disappointed.
Why has the falling dollar boosted exports less than expected? The less than expected growth in exports is because of the global economic slowdown and soft economies of other countries. Seasonal buying patterns of consumers also play a major role. Consumers have to wait for a while to make sure that the exchange rates are not reverted.
Exporters don’t expect to see any effects from the dollar’s fall for some time even if there are prior contracts in effect or the buyers have overstocked inventory. But in the long run exporters gain from these when the dollar falls.
Eventually, the declining dollar has to help exporters because the products become cheaper and more competitive in global markets.
Exporters will also focus their attention on China pegging the yuan to the dollar. By pegging the Chinese yuan to the dollar, Chinese exporting manufacturers are much more competitive in global markets. Even with a declining dollar, US exporters find it hard to compete against Chinese exporters who have the benefit of a pegged yuan. Hence the US exporters are focused on China pegging the yuan and are looking for a float in the Chinese currency.
The article assumes the Chinese yuan will go up if the Chinese government lets it float instead of pegging it. That would be good news for some and bad news for others.
If the Chinese government lets yuan to float, the value of yuan will go up. As a result, the operating costs of anyone who is manufacturing in China or buying parts or goods from Chinese manufacturers will increase.
