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China’s Undervalued Currency And U.S.A Senate Bill

In a move that may cause an unprecedented disruption to the delicate balance of trade negotiations between the United States and China, the United States Senate has passed a bill aimed at punishing China for allegedly manipulating its currency and holding it at an artificially low level.

Bill 1619, known as the “Currency Exchange Rate Oversight Reform Act of 2011,” passed by a majority of 63-35 in the Democrat-controlled Senate faces stiff opposition in the Republican-controlled House of Representatives and also from the White House.

Under the bill’s proposals, the administration would be required to identify “fundamentally misaligned currencies” on a semi-annual basis. As a preliminary step, the bill would task the Secretary of the U.S. Treasury to seek to consult bilaterally with “the country that issues such currency in order to facilitate the adoption of appropriate policies to address the fundamental misalignment.”

If the misalignment were not corrected at that point the bill would then start introducing penalties, initially via multilateral platforms including the International Monetary Fund and the Overseas Private Investment Corporation.

In the case of what the Senate bill describes as “persistent failure to adopt appropriate policies”, that is, if there was no remedial action taken 360 days after the currency in question was identified as misaligned, Congress would then authorise the administration to take action at the World Trade Organisation.

It would also permit the U.S. government to directly attack the price misalignment in the export sector by adjusting the calculation of the export price under the U.S.’ current antidumping laws, a move towards subsidies and trade protectionism that, some warned, could spark off a wider trade war with China.

While China was nowhere named directly in the bill, a bitter brew of contention between China and the U.S. over the currency issue has been simmering for several years now.

Responding to the passage of the Senate bill Chinese Foreign Ministry spokesman Ma Zhaoxu said in a written statement, “China calls on the U.S. government, its Congress and various communities to oppose the pressure put on the RMB exchange rate by domestic legislation and to tackle trade protectionism.”

Turning the Senate’s argument on its head Mr. Ma argued that the U.S. Senate was “essentially practising trade protectionism by making an accusation of currency manipulation… which is a serious violation of the rules of the World Trade Organisation”, a sentiment also echoed by China’s Commerce Ministry Spokesman.

Why is China’s Currency undervalued?

Beijing’s burgeoning foreign-cash pile is a consequence of its effort to boost exports by fixing the value of its currency, the yuan, to the U.S. dollar. To keep the yuan from appreciating too quickly, the central bank buys up dollars brought to China by foreign investors and Chinese exporters. Then the bank issues bonds to mop up the yuan it has paid for those dollars, thus warding off inflation.

In simplest terms, the Chinese government does not allow the global market of currency traders determine the exchange rate between the dollar and the rmb. The government has a monopoly on currency exchange to enforce this.

If global currency traders could set the value, the rmb would be worth a lot more and the dollar a lot less. There are many reasons for this, but the bottom line is that the market knows what the value should be, and the Chinese government isn’t letting it go there.

Imports and Exports either contract or expand the economy, which in turn determines the value of a certain currency. If country A sold a lot of things to country B, then country A becomes richer. Subsequently, country A’s currency will be in higher demand, since people want to invest in this growing economy. Higher demand for the currency drives the currency value up. This means that someone from country B who previously invested in country A at a lower price now has to spend more B-currency to buy the same amount of A-stuff. Kind of make sense so far?

This operates under the assumption that the government allows the currency to fluctuate depending on the global economy. It’s got a fairly stabilising effect, since if the currency grows too low, people buying the cheap labour and products will drive it up, but if it gets too high, then less people will be willing to pay the exorbitant price.

The Chinese government is suppressing the Yuan, so that it continually trades at about 7 or 8 RMB to the dollar. This means that labour and products will continually be cheap, leading to more countries buying from China, which essentially is an increase in Chinese exports. Exports inflate the economy since it’s foreign money being injected, which has partially helped the rapid growth of the Chinese economy.

If the Yuan were to fluctuate with Supply and Demand, then the RMB would be much higher, and western economies like the US and Europe would have more of a fighting chance in terms of manufacturing things like clothes or toys or everyday household items, which would help stunt the exponential economic growth China’s currently going through.

The Chinese government wish to keep the currency undervalued because:

  • A weaker exchange rate makes exports more competitive and increases demand for Chinese exports.
  • Chinese economic growth is dependent on exports, so the value of the currency plays a key role in boosting growth
  • China needs high growth. China’s economic growth is remarkable high by global standards. But, because of the switch from a state controlled industry to free market economy, there is still a problem of unemployment. Growth in exporting manufacturing industries plays a key role in creating jobs that are being lost in agriculture and other privatised state owned industries. With little welfare support for the unemployed, the Chinese government are concerned about social unrest should unemployment rise in the overcrowded cities.

Disclaimer: This article has been sourced from Crack Exams.

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