China Exchange Rate The Road to progress Li Chun Hin Sin Shing Him

Definition of Exchange Rates  The price of one country's currency expressed in another country's currency. In other words, the rate at which one currency can be exchanged for another.  the higher the exchange rate for one RMB in terms of one HKD, the lower the relative value of the HKD.  An appreciation of a currency implies a depreciation of another currency

Factors affected by exchange rate  Interest rates  Price level ( Inflation & Deflation)  the state of politics  the economy in every country  Import, Export (NX)

History of RMB(Before 1994)  The renminbi was first issued before the takeover of the mainland by the Communists in  The purpose of issuing RMB is to end the hyperinflation  During the era of the command economy, the value of the RMB was set to unrealistic values in exchange with western currency

History of RMB( Before 1994)  With the opening of the mainland Chinese economy, a dual track currency system was instituted, with renminbi usable only domestically, and with foreigners forced to use foreign exchange certificate  The unrealistic levels at which exchange rates were pegged led to a strong black market in currency transactions.  In the late 1980s and early 1990s, levels and the dual track currency system was abolished.

Trend of the Exchange Rate of China

History of RMB( After 1994)  In 1994, China reformed its double-track exchange rate system and introduced the unification of exchange rates. After the unification, China instituted a managed floating exchange rate regime based on market supply and demand.

Exchange rate of the American dollar vs. China‘s Currency (Renminbi)  From 1994 until July 2005, the policy on currency has been to peg informally the value of the renminbi against the value of the United States dollar.  This policy was praised during the Asian financial crisis of 1998 as it prevented a round of competitive devaluations.

Exchange rate of the American dollar vs. China‘s Currency (Renminbi)  In 2003, this policy came under criticism by the United States.  The value of USD falls  The value of RMB falls as well  exports more competitive  United States requires China to increase the value of RMB  increase import & decrease export

Case study Sino-US Trade imbalance. Should China appreciate RMB?

Background  In 2003, United States requires China to increase the value of RMB  Reason: 1. US has a huge trade deficit 2. To narrow down the trade deficit 3. Imports from China become more expensive and trade deficit and balance of payments will automatically improve. 4. Unfair to US worker US recommend China to appreciate RMB by 40%

Response of China  China did not appreciate RMB by 40%  changes its exchange rate system to managed floating system in appreciated by over 20 % against the US dollar from 2005 to  China further deepened the reform of the yuan exchange rate mechanism in July  China's trade surplus against the United States has still increased by a large margin during the period of time.

The trade balance of China CASE STUDY 1

The trade balance of China  Over 80% of the surplus came from US and Europe.  Has a big deficit between Asian countries(e.g. Tai Wan,Korea )  China's trade surplus against the United States has still increased although China has already appreciated RMB.

Why US always blame CHINA? Sino-US Trade imbalance Sino-US Trade imbalance

Fact of Sino-US Trade imbalance  US did not consider the value-added of the goods  Example 1 China is exporting a car which worth USD The actual domestic valued-added is only USD We should only calculate USD 2000 as the trade surplus.

Statistic of Sino trade imbalance

 China to the US: value-added is about 38%  The US to China: value-added is 87.3% (They produce high-tech products)  After making adjustment, the true trades deficit of the US to China in 2005 is only US$ 39.6 billion  A great contrast to the US$201 billion recorded by the US  China only gain as little as they cannot imagine

Cause of Trade deficit  In the national income accounting, we can have some to prove that.  income= expenditure  Y=C+I+G+NX (1)  Y=C+S+T (2)  Combine (1) + (2)  C+I+G+NX=C+S+T  NX=(S-I)+(T-G)

Causes of trade deficit  NX=(S-I)+(T-G)  Interest rate in US is low  Encourage people borrow $ from the banks  I>S  (S-I) should be negative.  In US, government spend much $ on military and education. Indeed, tax income cannot cover the expediture  (T-G) should be negative as well  NX=(negative number)+(negative number) =negative number

Causes of trade deficit  The policy of export control of High-tech product  The US does have competitiveness in high- technologies and value of those products are high  To loosen the export control, trade deficit can be decreased  For example :after 911,US enhance the export control, the trade deficit of high- tech product is increased from 26800million to 37000million from

Causes of trade deficit  Most of the goods imported from China is necessities.  The elasticity is rather low.  If China appreciate RMB,  The trade deficit of the US will be even larger than now.

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