What if China forever pegged to dollar ?

[Delawaredave5]

What happens if China does not allow their currency to appreciate and move upwards relative to dollar ?

Is their anything in their interest to let their currency appreciate ?

I remember the "Japanese invasion" in the 80's - where their imports were taking over US. Then it was 200 yen/dollar. Now it is less than 100. Their currency appreciation against the dollar seem to have "balanced out" trade between both companies.

If China just held current exchange rate - would they just continue to "suck the wealth" out of the US ?

I do not understand any downsides to them on continuing their current practice.

 

[traineeinvestor]

I'll steer clear of China's social problems which are of very real concern to China's rulers given the rules for this forum.

However, the downside case from China's perspective is usually cited as:

1. a sudden move in FX rates would be destabilising

2. upward appreciation would make exports less competitive

3. the value of their existing FX reserves would fall

IMHO, #1 would justify a gradual move to a fully convertable floating exchange rate. #2 could be cited by any countries for justifying artifical exchange rates as well as other barriers to free trade.

Incidentally, one of the consequences of greater convertability of the yuan and a rising RMB/USD exchange rate would be Chinese companies (the biggest of which are mostly state controlled) being freer to invest overseas (which is already happening to an extent). Given the size of China's economy and the size of its reserves, the buying power would be considerably larger and more widespread than Japan's in the 1980s.

 

[brewer12345]

If they pegged forever, they would likely eventually see inflation run wild and/or accumulate such a large USD pile that it would be destabilizing to the world currency markets.

My best guess is that China gradually allows the Yuan to appreciate once the crisis is over, but that they will do it with enough fits and starts to keep the markets guessing.

 

[MasterBlaster]

Now that they have one of the largest economies in the world. How does the rest of the world let them get away with not floating their currency ?

What if every other country said... We won't honor your (fixed low) rate ?

How did we let this happen ?

 

[Delawaredave5]

If they pegged forever, they would likely eventually see inflation run wild and/or accumulate such a large USD pile that it would be destabilizing to the world currency markets.

I'm not smart enough to understand how pegging their currency to ours would increase their inflation.

It does seem to me that staying pegged to a falling US dollar devalues their USD reserves incredibly - which is why they want to diversify their foreign currency reserves into Euros and other currencies.

Political pressure aside, seems like staying pegged until their labor rates increase to US levels is the most effective way for China to "suck the wealth" out of the US - and I think they're going to stay latched to the dollar as long as they can.

 

[traineeinvestor]

The Hong Kong dollar is pegged to the US dollar. One of the consequences is the effect on asset prices. At the moment, the HK Monetary Authority (the local equivalent of the Fed) is flooding the market with HK dollars to prevent the currency rising and interest rates are very low (zero for short term deposits and 1% for mortgages which are readily available). A lot of that money is finding its way back into the property market where prices are more or less back to pre-crisis levels. In effect, the currency peg has caused asset price inflation.

During the Asian crisis the position was reversed with the HKMA buying HK dollars to prevent the currency falling below the pegged level and this contributed to property prices falling more than 60% (there were other factors at work as well).

The PRC situation is more complex, but one of the consequences of a weakening currency is that imports cost more which leads to higher inflation. You also get investors buying your currency and, those who buy currency, either put it on deposit with a bank in the PRC (which means more money is available for loans and at a lower cost, which leads to more borrowing which leads to asset price inflation etc) or invest it directly (which also leads to asset price inflation).

 

[brewer12345]

dave, trainee explained it very nicely.

 

[lhamo]

And actually, the RMB is not fully pegged to the dollar -- hasn't been since 2005, when they switched to using a "basket of currencies" to determine exchange rates. The rate has declined from around 8.26 (where it was pretty consistently from around 1999-2005) to the current rate of around 6.8, a 17% devaluation. We expect it will decline further after the immediate crisis is over. Sucks for those of us who have mostly local expenses in RMB but who get paid in dollars -- we have hedged for the future by investing in real estate.

 

[traineeinvestor]

lhamo - how hard is it for non-PRC nationals to buy real estate in the PRC? I looked at buying in Shanghai a few years ago and decided not to because of concerns over security of title and difficulties in getting a non-paying tenant to leave. Tax and FX repatriation were painful by Hong Kong standards but not impediments.

 

[lhamo]

I should clarify that our investment in real estate is in the sense of owning our own residence, not being landlords. In Beijing, foreigners are not currently allowed to buy property to rent out -- you can only buy it for your own use, and you must have a resident permit and have been in the country for at least 12 months. The rule about self-use isn't totally enforced, but it is there and compounded by the fact that all foreigners have to register their residence at the local police station if they are staying in a private residence (not a hotel or dormitory). So it is not currently a place you want to buy property to rent out to others, if you ask me. There are no annual property taxes (though property management fees and heat can be a significant, and inescapable, expense), and though taxes on the sale are technically supposed to be paid by the seller they are actually paid by the buyer. Foreign exchange regulations can get tricky, but there are ways around it -- in our case we had a contract denominated in RMB, but the sellers were US citizens with accounts in HK, so we paid a big chunk of the cost in US$ via direct transfer to their offshore accounts. We expect we will seek a similar buyer if/when we decide to sell. The particular complex we live in has very high ratio of expat residents, and ours is a very desirable unit, so we don't anticipate much trouble selling. We bought literally at the bottom of a recent dip in the market, and current asking prices are roughly 50% higher than what we paid. Has had a very nice effect on our net worth. Knock wood!

 

[semtex]

I doubt it will peg to dollar forever. A clear fact is dollar is losing value day by day and chinese yuan will appreciate eventually.

In my view, one day chinese yuan will cut the peg with dollar for sure, but same time, we have to pay chinese yuan to purchase china stuff. the later scenario is more scary. in fact, it is happening at east southen asia already.

 

[lhamo]

BTW, local constables came knocking on the door yesterday to check our registration status. So you probably don't want to be renting to people illegally...

And here is what Wikipedia has to say about how exchange rates are set for RMB:

"Improving current account balance during the latter half of the 1990s enabled the Chinese government to maintain a peg of 8.27 yuan per USD from 1997 to 2005. On 21 July 2005, the peg was finally lifted, which saw an immediate one-off RMB revaluation to 8.11 per USD. The exchange rate against the euro stood at 10.07060 yuan per euro. The RMB is now moved to a managed floating exchange rate based on market supply and demand with reference to a basket of foreign currencies. The daily trading price of the U.S. dollar against the RMB in the inter-bank foreign exchange market would be allowed to float within a narrow band of 0.3% around the central parity published by the People's Bank of China (PBC); in a later announcement published on 18 May 2007, the band was extended to 0.5%. The PRC has stated that the basket is dominated by the United States dollar, euro, Japanese yen and South Korean won, with a smaller proportion made up of the British pound, Thai baht, Russian ruble, Australian dollar, Canadian dollar and Singapore dollar.

On April 10, 2008, it traded at 6.9920 yuan per U.S. dollar, which is the first time in more than a decade that a dollar bought less than seven yuan, and at 11.03630 yuan per euro.

On September 30, 2008, the renminbi traded at 6.7899 yuan per U.S. dollar, which is a 21.9% increase and the highest rate since the removal of the peg. The renminbi has remained at a value of around 6.83 per U.S. dollar since July 2008, oscillating around a narrow band, which in practice amounts to a re-pegging of the renminbi against the dollar."

(from Renminbi - Wikipedia, the free encyclopedia with footnotes removed)

 

[ultimo]

"Now that they have one of the largest economies in the world. How does the rest of the world let them get away with not floating their currency ? What if every other country said... We won't honor your (fixed low) rate ? How did we let this happen ?"

How did we let it happen? We really don't control the world, and other countries make decisions based on their own economic needs. The U.S. is famous for demanding currencies to float and then demanding that they be pegged, depending on how the U.S. is doing. A higher yuan would severely impact Chinese exports, reduce employment, etc., etc. When has the U.S. ever manipulated its own currency purely to help out another country, when doing do would negatively impact our own economy?