Should_China_Lower_Its_Exchange_Rate

Should China Lower Its Foreign Exchange Rate' If you ask what the hottest topic in the current financial market is, it is definitely the “rate war” between China and the United States. This term can be understood as a game with respect to the RMB (China currency) exchange rate’s appreciation. The United States believes Chinese currencies are probably undervalued against dollars, so Chinese currencies ought to gradually appreciate. According to a journalist Liu Qianyu, the US Treasury Secretary Tim Geithner announced on the congressional hearing in September to take measures to push the RMB to appreciate (par.1). However, Chinese Premier Wen Jiabao called on the world to objectively and fairly treat the RMB exchange rate issue while visiting Europe in October, 2010 (Yan, Par.1). The exchange rate issue is not simple about money conversion; rather it concerns the financial system, the economic growth and the trade balance. Particularly, the exchanges rate of a country with influential economic power plays a significant role in the international financial market, and the country’s exchange rate fluctuation even influences the other economic entities. Therefore, China as the largest developing country should not appreciate its exchange rate based on three reasons: boosting export trade and maintaining social stabilization, avoiding speculative activities and contributing to the world economy. The first step in knowing why China should not appreciate its foreign exchange rate is to understand the exchange rate’s definition and its effects on international trade. An exchange rate can be defined as the rate “at which one currency is converted into another” (Hill, Global, 65). When a foreigner is shopping in another country, he or she will consider an exchange rate factor. He or she will convert foreign prices into domestic prices using the exchange rate method and get them compared, which happens commonly. It is true that some Canadians, while they are visiting China, find the costs of a lot of products such as food, clothes and beverage, are much cheaper than those produced at home(the Canadian dollar exchange rate against RMB usually is 6.8). Even though some products made in China display in Canadian supermarkets, they still have a price advantage. Therefore, the products from China are popular with many Canadians. All these are, to some extent, attributable to the exchange rate effect. If things change, let us imagine another situation where the RMB appreciates that a dollar is worth a RMB. Canadians would find the products from China less attractive because they were more expensive when adding duties and transportation costs. So they might stop buying some Chinese products, which would deteriorate China’s exporting situation and thus would generate trade deficits. Put simply, trade deficits mean domestic resources flowing outside and international debts increasing, which all go against the economy’s sustainable and prosperous growth. When we look closely at what happens to the domestic companies relying on exporting, it is not hard to find they might get in trouble due to export difficulties and backlog. What is worse, if the situation does not improve, these firms might go bankrupt and the employees working for them might be laid off and thus the probability of the economy being depressed go up. Another reason to stabilize exchange rate is that the exchange rate’s appreciation will create an opportunity for speculators (a person who trades currency with a high risk in return for a high profit) to engage in foreign speculative activities. A foreign speculative activity means a speculator anticipates a country’s currencies may appreciate in the future so he will purchase a large amount of the country’s currencies today and will sell them for a higher price one day. However, the consequences of the speculative activities are disastrous and dissolving to a country’s economy, especially to the asset markets, such as stock market because it creates economic volatility, and thus misguides people’s expectations and judgements and causes economic chaos(Jonathan 9) . A vivid example about the exchange rate fluctuation and its effects is the Japan financial crisis. While the Japanese economy was growing during the 1980s, America was afraid of losing the first place in economy and thus forced Japan to sign the Plaza Agreement aimed to increase the Yen’s exchange rate. Because of the expectation of the Yen’s appreciation in the future, it attracted more speculators to invest their money into Japan’s asset markets in hope for the profits gained from the increasing exchange rate. Thus, due to the influx of a large amount of money to purchase limited assets, the values of Japanese stocks and real estate rose rapidly. However, when these speculators earned a large amount of money, they left Japan’s asset market with all the money, leading to the shattering of the Japanese economic bubble (the market value of a product is greater than its real value). The aggressive run down of stocks and real estate, the collapsibility of the financial system and the loss of people’s confidence almost paralyzed Japan’s economy overnight. The Japanese spent ten years paying for their uninformed decision—appreciating the Yen. The whole 1990s is also called the “lost decade” in Japan (Wang, Japan par.1-3). Now the situation in China is incredibly similar to that in Japan at the beginning of the 1990s. First, the White House presses China to increase the RMB exchange rate, and then the representative of the speculators, George Soros, brought 90 billion dollars to enter Hong Kong, ambitiously aiming at the whole financial market on the mainland. It was reported that Soros had already been ready to invest in China’s financial market to gamble on the RMB appreciation (Wang, Soros par.1). If Soros won the gamble, what China would be like and how long would Chinese spend paying for the cost of the exchange rate’s appreciation' If the worst of it is that China as the “World Factory” collapsed, who would pay' Not just China itself. Furthermore, keeping China’s foreign exchange rate relatively stable is to contribute to the world economy and to boost its growth. First, it is a fact that RMB keeps appreciating relative to the dollar and the euro. According to a journalist Wu Qimin, since July 21, 2005 when China finished the reform of the mechanism for setting the exchange rate, the exchange rates of the RMB against the dollar and the euro have gone up 21.2% and 4.6%, respectively (par.4). That is, China’s exchange rate system lives up to the market economic mechanism and thus it should not be intervened by other political powers. Because of the stable and continuing growing Chinese economy, partly attributable to the stable exchange environment, China has significant effects on stabilizing the world economy. The contribution reflects in two aspects: one is that a series of investments, stimulating domestic demands and worldwide purchasing policies is succeeding in helping China and other countries build confidence and promote their economies’ development after the 2008 financial crisis. Second, China plays a leading role on keeping its own currency stable and adjusting to market mechanism demands, which avoid the cutthroat competition of different currencies’ depreciation against each other. Moreover, China’s stable exchange rate also positively influences the international financial markets, reducing the uncertainty of market risk resulting from exchange rate fluctuation and correctly guiding people’s expectation in foreign exchange rate. A successful example about China boosting a sluggish economy is that China successfully controlled the situation during the Asian crisis through implementing a series of exchange rate policies. Therefore, it laid the foundation for the subsequently recovering economy and stimulating surrounding economic development. Specifically, after the 2008 financial crisis, the Chinese government took positive measures to help stabilize the domestic and international financial market along with the foreign exchange market as it did during Asian crisis, such as controlling money supply and adjusting interest. The reason for the initiatives is that expansionary monetary policy (expand money supply) can lead to inflation and the value of assets dropping; that is, the interest rate goes down. Then, low interest rate will reduce the attractiveness of domestic assets and thus lead to capital outflow, which is unfavourable to an economy’s recovery (Dornbusch 1161-1176). To conclude, stabilizing China’s foreign exchange rate has profound significances to the world economy’s recovery and development. In my point of view, one country’s economic growth and trade development should not be at the cost of other countries’ interests. The best ways to boost economic growth are to eliminate trade conflicts and to focus on economic coordination, the final purpose of which is to benefit every county which engages in the world trade. Stabilizing China’s foreign exchange rate is walking towards the goal of lasting peace and common prosperity. Works Cited Dornbusch, Rudiger. “Expectations and Exchanger Rate Dynamics.” The Journal of Political Economy 84.6 (1976): 1161-1176. Print. Hill, Charles W. L. and Thomas Mckaig. Global Business Today. Canadian ed. New York: McGraw-Hill, 2006. 65. Print. Hill, Patrice. “Penalties sought for China over currency practices.” Washington Times 16 Sep. 2010: A1+. Print. Liu, Qianyu. “America May Punish China for RMB Appreciates A Little Bit Slow.” The Liberty Time. 18 Sep. 2010. Web. 14 Nov. 2010. Jonathan D, Johns, J. Harold Mulherin, and Sheridan Titman. “Speculative Trading and Stock Market Volatility.” Finance 21.3(1990): 9-13. Print. Wang, Dan. “Solos Is Back to Hong Kong Again, Carrying nearly 90 Billion.” IFeng. 11 Oct. 2010. Web. 14 Nov. 2010. Wang, Wei. “Japan Financial Crisis.” Yan Zhao City. 10 Mar. 2006. Web.27 Oct. 2010. Wu, Qimin, and Dongzhe Wei. “China’s Exchange-rate Policies Will Boost World Economy’s Recovery.” People’s Daily. 04 Feb. 2010. Web. 14 Nov. 2010. Yan, Yang. “Chinese Premier Calls for Fair Treatment to RMB Exchange Rate.” Xinhua. 06 Oct. 2010. Web. 14 Nov. 2010.