Based on the newspaper article: Stronger Yuan may create other problem. This assignment will discuss what the effects on international trade and domestic market from appreciating of Yuan. Also briefly analyze how China government takes measures to deal with the impact caused by the appreciation to their economy.
Since the global economic crisis at 2009, the appreciation of RMB is now a focus point in the international market. With U.S and the developing countries such as Brazil and India has been criticizing the undervaluation of Yuan and pressuring the China government to appreciating their currency.
"As I've said before, China moving to a more market-oriented exchange rate would make an essential contribution to that global rebalancing effort," said U.S president (BBC, 12.03.2010).
Because of its currency undervaluation, china able to export its good cheaply to other countries, in result a greater demand of china product comparing to other countries and this affecting other countries including U.S to lose their competitive advantages by lowering down their export price. Since demand for foreign goods in china is also low which mean china importing goods into domestic market is low. This helped china created a huge trade surplus with the rest of the world (Fig 1.1) and the world has a trade deficit with china. E.g. US trade deficit with china (Fig 1.2). With low exchange rate, foreign companies started to invest in china more rather than their parent countries and china companies avoided investing into foreign countries such as U.S due to low rate of return in investment.
Fig1.1 China's Trade with the World ($ billion)
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Note: PRC exports reported on a free-on-board basis; imports on a cost, insurance, and freight basis
Sources: PRC National Bureau of Statistics and PRC General Administration of Customs, China's Customs Statistics
NOTE: All figures are in millions of U.S. dollars on a nominal basis, not seasonally adjusted unless otherwise specified
SOURCE: U.S. Census Bureau, Foreign Trade Division, Data Dissemination Branch, Washington, D.C. 20233
2. Effects on U.S and Rest of the World
With the appreciation in yuan, the main beneficial will be the U.S, the developing countries such as Brazil, ASEAN and china's imports industries. The reason being china's exports will become more expensive, countries gaining back their exports competitive as they no longer need to lower their exports price to gain competitive advantage as a result china face stronger competition from the international market. China import will be greatly being in demand as foreign goods are now more affordable due to china consumers' purchasing power boosted. China's investors and companies will also be happy as they able to invest into U.S and other developing countries with lower exchange rate and cost of production become lower. As exports and investments into china increased, more labours is needed to meet the demand of import into china and for newly invested company, this bring unemployment rate in U.S and other countries lower helping to ease the recession situation faced by them. With more exports and investments for the US and the rest of the world, aggregate demand increased shifting the AD line upward, AD1, and raising national real GDP (Fig2.1) closing the recessionary gap ( from R to R1).
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Fig 2.1: Effect on rest of the world
On the other side, appreciation in Yuan does not benefit foreign investors in china and local and foreign companies in china which in production industries. Investors and companies such as Microsoft is unhappy due to the cost of capital increased and rate of return is low for their investment and cost of production will be higher for the latter as price of raw material requires to be imported into china will be more costly. This will resulted exporting price in china to high and lowering the demand for good produced in china. (D0 to D1) (Fig 2.2)
"The world is so intertwined that companies like Microsoft are making a lot of investments, especially in R&D, in China. We manufacture things like the Xbox from China and export to the rest of the world, so when there is a yuan appreciation, obviously that will add to costs. That will make the price of the product higher and the US customer will have to pay more. So I don't understand how that will balance the deficit.' (zhang yaqin, corporate vp, microsoft, Straits times, Apr 10 2010)"
Fig 2.2: Increase in demand
3. Effects on China
Because of the high exports rate, unemployment in china is relatively low as more labours is required to produce goods in order to meet its demand in the international market. But rise in yuan will cause china to face stronger competition in domestic and international market. With more import into china, domestic price level has to fall in order to compete and export price getting more expensive, demand decrease and cost of production increases thus labours will be cut down to produce less. This cause unemployment rate in china to increase and consumer will cut down on consumption. Where AE=C+I+G+(EX-IM), lesser investment, high unemployment rate and low consumption will cost the GDP of china to reduce. AE =C +I +G+(EX - IM). China huge foreign reserves will also suffer loss. China can also benefit from the appreciation in yuan. Firstly, with export in low demand, local companies may forced to upgrade their technology and product in term of quality supporting by lower cost of foreign technology, enhancing local companies competitive advantage. Secondly, with inflation remain high in china; raise in yuan can counter the effect as more money is needed for investment e.g. real estate in china and lower rate of return, consumer will decide to deter investment causing the price level to fall. (D0 to D1) (Fig 3.1). Lastly, china foreign debt will be reduce due to lower exchange rate.
Fig 31 Decrease in demand
4. Countermeasure on by China
Expansionary monetary policy
With recession in place because of appreciation in yuan, China government may employ expansionary. With Money supply increase, interest rate in domestic market falls (Fig 4.1) and this will attract investor back into china as rate of return increase. With increase in investment, and consumption due to increase in employment GDP naturally will increase fight the recession caused by the appreciation. (Fig. 2.1).
Fig 4.1: Money supply- fighting recession
Money supply increase will not have effect on exchange rate even though interest rate is low as china has a fixed exchange rate, thus no possible international effect.
Expansionary fiscal policy
Another way to counter recession, government spending or tax revenues decrease, this refer as expansionary fiscal policy. A demand for good and supply will increase due to an increase in consumption demand which will increase the china GDP. But it also increase the demand of money supply and caused the interest rate to increase.
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Interest rate increase will not have effect on exchange rate as fixed, therefore is good for international market as no negative effect.