Ever since China adopted its Open Door policy, it has received unparalleled attention from international scholars. In recent years, this has been evident with respect to the exchange rate regime that China has applied. At first, the policy was lauded because it helped China steer the dire waters of the Asian Crisis that occurred in the late 1990s. Even after the world entered the new millennium, the exchange rate regime has been heavily criticized. Most of this criticism came from the USA, since they placed China at the top list of who to blame for the worsening trade deficit, especially referring to the undervalued nature of the Renmimbi (RMB). However, this is just a part of what we address in this paper. In the first part, we will explain the current situation in China. We will see how the Chinese exchange rate regime changed from a dollar peg, to a peg based on the existing basket of currencies.
[...] On April for the first time in more than a decade, the dollar bought less than 7 Yuan, ending the day close to a situation that specialists say will probably make Chinese-made goods more expensive for American consumers and possibly contribute to inflation in the United States; indeed the Yuan has gained about 16 percent against the dollar since the peg ended in 2005, including about 4.5 percent this year, and some analysts believe the Yuan will continue to rise, possibly reaching 6.5 Yuan to the dollar by the end of the year, stated Barboza D How could we determine the equilibrium value of the Chinese renminbi under a flexible exchange rate regime? [...]
[...] In the next section we will have a look at some pros and cons of floating the RMB Risks and opportunities commercial participants would face if China decided to freely float the RMB and other risks investors face in China? As trade and investment are significant aspects of the Chinese economy, re- evaluating the currency would present both investors and commercial actors with substantial risks as well as potential benefits. This part presents the options available to commercial actors should China decide to freely float the RMB. [...]
[...] Such a shift in the competitiveness of Chinese products could pose risks to investors who have invested substantial sums of money in Chinese industries in hopes of cashing in on the nation's low production costs. Ryan (2006) agrees, suggesting that such an increase in the price of exports will lead to unemployment as Chinese firms look for new ways to cut costs and retain their competitive edge. As exports are a significant aspect of the way in which the Chinese economy does business, Morrison (2007) argues that a reduction in exports may send negative reverberations throughout the economy. [...]
[...] Nevertheless, no matter the regime they see it as optimal for China as it ‘maintain[s] competitiveness while avoiding a trade war with the Americans [and] is also consistent with the practice of stabilising exchange rates against the dollar without a strong commitment mechanism, which is what the Asian countries indulged in following the Asian crisis of the 1990s' (Moosa, Naughton and Li; 2006; p.29). Thus on the face of it, it may seem that China changed its regime just to calm the pressures coming from America. [...]
[...] China is currently the world's fourth largest economy and second largest economy on a purchasing power parity basis with GDP of 3.25 and 6.99 trillion US dollars, respectively in 2007 (appendix 1). Also, China has a substantially export-oriented economy. It is indeed, as stated in the CIA Wold Factbook, the world's third exporter with 1.221 trillion f.o.b. US dollars in 2007 behind its main trading partner, the United States of America, and Germany. Although having achieved one of the most sustainable growths in world's history and a deep integration in the world's economy, the economic system of China is often said to be close to overheating and presents some negative aspects. [...]
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