Archive for April, 2012

Chinese Currency Independence………Good, Bad, or Indifferent?

The current administration feels that the Chinese Yuan has been artificially depressed since it is pinned to the US dollar with only a 0.5 percent allowable deviance. Therefore, while the US economy was having trouble and the Chinese economy was running wild with a 10% growth rate, the depreciation of the US dollar was not able to help the US sell more products in China due to a currency advantage.

Normally, with a strengthening economy, a country should see its currency get stronger as  growth would lead to inflation, which would then lead to higher interest rates in that country, and then to a stronger currency. This is what should have been happening in China over the last few years. If it had, the Chinese yuan would have been stronger which, combined with the weakness of the US dollar, should have made it very attractive for the Chinese to purchase US products. (US products would have been cheaper than comparable Chinese products due to the currency exchange rate).

This did not happen because the yuan was closely pinned to the US dollar meaning that as the dollar declined, the yuan declined with it thereby becoming cheap and neutralizing the advantage in trade between the US and China. This made the yuan artificially cheap……which it was.

China knew it was going to have to loosen its currency’s tracking of the US dollar if they wanted their currency to be recognized as a globally accepted currency. They just needed to pick a time to do it. They picked now and picked the timing well. With the Chinese economy slowing down significantly, the yuan should drop naturally so it won’t track with the dollar and strengthen as it would have a few months ago. That protects Chinese products!

Beyond not having a trade advantage, I wonder if a free-floating yuan is the best thing for the US.  There has been a lot of talk about the dominance of the US dollar as the lone global base currency. Almost all commodities are quoted in US dollars. Several countries had expressed interest in changing that by putting together a basket of currencies to replace the dollar as the base currency. This plan, being proposed mainly by the Euro Zone, has been shelved for a while as the Euro has had and continues to have problems. However, China was very interested in this plan also but would not have been able to participate in this basket as their currency was not free-floating. This move was a first step in participating in that basket.

”Floating free” will allow the yuan to strengthen like we know it should and could allow for a little more “free trade” between China and the US.  That should be a good thing for the US.

However, the Yuan added to the basket of currencies to be used as a base global currency could also be a bad thing for the US.  It could be the beginning of the end for the dominance of the US dollar as the global go-to currency!