Unit 8 Case Study: Why Would China Want Its Own Currency

Unit 8 Case Study 1 Why would China want its own currency to be under

Unit 8 Case Study: 1. Why would China want its own currency to be under

Analyze why China might prefer to keep its currency undervalued relative to the US dollar, considering the potential economic and strategic benefits. Discuss the mechanisms China uses to manage an undervalued currency and the implications of such strategies on both domestic and international economies. Examine the motivations behind maintaining a lower value for the yuan, including boosting exports, supporting economic growth, and managing trade balances. Explore tools such as currency interventions, reserve management, and monetary policy measures that China employs to sustain the undervalued status of its currency. Evaluate the potential risks and benefits associated with maintaining an undervalued currency, both from China's perspective and for global economic stability. Consider historical and current examples to illustrate how currency management influences international trade, capital flows, and geopolitical relations. Provide a comprehensive overview supported by credible sources and economic theories related to currency valuation and exchange rate management.

Paper For Above instruction

The strategic decision of China to undervalue its currency, the yuan (Renminbi), has been a significant factor in shaping its economic growth and position in global trade. By intentionally maintaining an undervalued currency relative to the US dollar, China has aimed to foster an export-driven economy, improve its trade surplus, and stimulate domestic employment. This approach has provided Chinese manufacturers with a price advantage in international markets, thus increasing their competitiveness. Historically, China has managed this undervaluation through various methods, including persistent intervention in foreign exchange markets, holding vast reserves of foreign currencies, primarily US dollars, and adjusting monetary policy tools to influence the yuan’s value (Cohen, 2015).

One prominent method China employs is direct foreign exchange interventions, where the People's Bank of China (PBOC) buys or sells foreign currencies to influence the exchange rate. By purchasing US dollars with yuan, China can suppress the yuan's appreciation. Additionally, the country maintains substantial foreign currency reserves, which provide the financial backing necessary to stabilize or devalue the currency as needed (Cheung et al., 2019). These interventions aim to prevent the yuan from appreciating significantly, which could undermine the competitiveness of Chinese exports. Moreover, China’s monetary policies, including setting reserve requirement ratios and interest rates, further support the undervaluation goal by influencing capital flows and exchange rate expectations.

The rationale for maintaining an undervalued currency is rooted in multiple economic and strategic considerations. An undervalued yuan makes Chinese exports cheaper and more attractive abroad, directly supporting the manufacturing sector and sustaining high economic growth rates. This strategy also helps manage deflationary pressures and maintain employment levels in export industries. However, it introduces tensions with trading partners, especially the United States, which has labeled China a currency manipulator at times, accusing it of unfair trade practices (Li & Liu, 2020).

Despite the benefits, this strategy carries risks, including trade tensions, retaliatory tariffs, and potential loss of investor confidence if the undervaluation is perceived as artificial or persistent. Additionally, prolonged intervention can distort market mechanisms, leading to excessive reserve accumulation and currency mismatches. Recent shifts toward greater currency flexibility and market-oriented reforms aim to gradually reduce the undervaluation, but the strategic importance of maintaining some degree of undervaluation remains significant for China's economic agenda (Zhang, 2021).

In conclusion, China manages its undervalued currency through a combination of market interventions, reserve management, and monetary policy tools, driven by the desire to bolster export competitiveness and sustain economic growth. While this strategy provides short-term advantages, it also invites challenges that require delicate balancing and ongoing policy adjustments to ensure economic stability and international credibility.

References

  • Cohen, B. J. (2015). The Future of Money: How the Digital Revolution Is Transforming Currencies and Finance. Princeton University Press.
  • Cheung, Y. W., Chinn, M. D., & Qian, X. (2019). Currency manipulation, trade, and economic growth. Journal of International Economics, 115, 77–98. https://doi.org/10.1016/j.jinteco.2018.11.002
  • Li, J., & Liu, X. (2020). The geopolitical and economic implications of China’s currency policies. Asian Economic Papers, 19(2), 101–125.
  • Zhang, H. (2021). Reforms in Chinese monetary policy and currency management. Journal of Asian Economics, 72, 101273. https://doi.org/10.1016/j.asieco.2021.101273

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