Almost for 2 year’s Chinese government with the help of People’s Republic Bank Of China – the Chinese central bank had managed to keep the value of their currency Yuan pegged to the value of US dollar. One $ was worth around 6.82 Yuan.
China is an export driven economy. Their main export market is the US. So when an Chinese company exports goods to US it gets paid in US$. These $ are converted to Yuan, it means $ are sold and Yuan is bought. Over a period of times, as exports keeps going up, more $ are sold and more Yuan are bought. This of course increases demand for Yuan & it starts to appreciate or increase in value against $. And an appreciation in currency is detrimental to exporter.
This means, suppose say a Chinese exporter exports goods worth $100000. When he converts them at 1$=6.82 Yuan he gets 682000 Yuan ($100000x6.82) in return. Now say the Yuan appreciates and 1$=6.6 Yuan, then the exporter will get 660000 ($100000x6.6). Thus he will not make the same amount of 682000. If he wants to make the same money he will have to raise prices. It’s well known that Chinese compete on price & not quality, the exporter may not be in position to raise prices. This is were the government comes in by ensuring that the value of the Yuan stays constant around 6.82 to $, so that the exporter does not have to deal with any fluctuation in currency.
Government of china in order to maintain Yuan at 6.82 to $ starts selling Yuan & buys $. Because when lots of $ come into china to buy Yuan, pushes up the demand of Yuan & Central Bank of China starts selling Yuan & buys $. This ensures that there are enough Yuan in market & its value dos not appreciate.
Now China has suddenly decided to de-peg its currency as US feels that China is a currency manipulator, US feels that china has held the value of Yuan against the $ constant & this is what has kept their export machinery chugging along. They feel this has led to situation where Americans citizens continue to buy cheap Chinese goods instead of home grown ones.If Chinese government had not involved itself with the foreign exchange market & let it work independently then the flow of $ into china would have ensured that the Yuan would have appreciated against $.
Suppose if 1 $ = 6 Yuan, means exporter exporting goods worth $100000 would make 600000 Yuan. Under the pegged regime he would have earned 682000 Yuan. Now, to earn that much, he has to sell goods for $113666.7 (682000/6). This means he has to increase its price to 13.67%. This in turn would make Americans buy American goods instead of low priced Chinese goods. Nobel Prize winning economist Pual Krugman had earlier proposed to impose a 25 % surcharge on Chinese imports to US. He felt that this will make Chinese goods expensive & will result into Americans buying more US goods. Basically the allegation against china on being currency manipulator have been growing in US, and US the biggest market for china do not want US to take any strict steps that would hurt its exports. So it wants to de-peg it currency against US$.
Currently if something worth $1000 it will be worth 6820 Yuan in china if it is imported, if 1$ = 6 Yuan, then it would be worth 6000 Yuan which is lower. So some experts believe that this will make Chinese buy more imported goods & that in turn will help the exports across the globe. China will take time to change its spending habits. Currently china’s saving rate is 54 %.
And off course in order to maintain the peg, the Chinese Central Bank bought $ & sold Yuan that explains Foreign Exchange Reserve of $ 2.4 trillion. And all this money found its way back primarily into US & other western economies, helping them to finance their fiscal deficits. Now if these Chinese really let the Yuan float even partially, its rate of accumulation of Forex reserve might slow down. This means lesser $ to help finance the fiscal deficit in the US.
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