Pegging the dollar?

Question

If china were to fully unpeg the dollar, what would be the economical concequences?

It's not a homework question. I havn't started school yet >=[

Answer 1

Just some clarification of the issue first - China has 'pegged' the yuan against the dollar since around 1995. This means that they adjusted interest rates and monetary policy to maintain the international exchange rate of the yuan to around 8.3 dollars. In July 2005, they adapted the policy so that this yuan could strengthen slightly to around 8.1 dollars. Officially, they also said that it would be valued against a 'basket' or range of currencies (especially the Euro, the British Pound and the Yen), instead of just against the dollar. However, informally, the Dollar is still very much at the forefront of monetary policy in China.

The consequences depend on just how accurate (or innacurate) the current artificial value is compared to the real value that would happen if the currency were allowed to float freely (i.e. the peg were removed). Some say the Yuan is extremely undervalued, and many Congressmen argue that China wants to keep it that way so that it can flood cheap goods onto the US market. The argument that they should remove the peg is that, if the currency were allowed to float, then the price of imported Chinese goods would rise, and US firms would be able to compete and jobs would be saved. This is extremely simplistic, however.

For a start, a lot of imports from China are not finished products - therefore, they provide work in the US anyway. If the peg were removed, the prices of these products would rise also, causing some unemployment in this area.

Secondly, if prices were allowed to rise, this would contribute to inflation in the US. In a period when inflationary pressures are already strong (due to high energy and commodity prices), this would be extremely damaging. Higher interest rates are undesirable due to the flagging housing market, so a mini-recession would almost certainly ensue.

However, the biggest argument against removing the peg is that the surplus capital that the cheap Yuan is creating in China is being used to support the US market. Without it, the post-dotcom bubble recession would have been much deeper and longer. Chinese money is also supporting the US government's enormous deficit, so interest rates have been able to stay artificially low. Hence, if China removed the peg, long-term interest rates would rise in the US, adding yet further pressure to the economy, and this without dampening the inflationary pressures mentioned earlier.

Finally, there is some argument that the Yuan is not as undervalued as some people are suggesting. There is still high unemployment in large areas of China, and the weak Dollar is a result of poor economic management in the past few years by the US Government. The massive PSBR (i.e. Government borrowing), combined with an enormous trade deficit, means many investors have lost confidence in the Dollar. Therefore, the apparent 'strength' of the Dollar compared to the Yuan is only an illusion perpetuated by politicians who don't want to admit poor economic management.

Hope that helps. International currency markets are not for the fainthearted, and are probably one of the hardest areas to start learning economics. Good luck though :)

Answer 2

First of all, China used to peg yuan to the dollar (not the other way around). Second, this peg has been abolished more than a year ago. Third, the economic consequences would most likely be negligible; there is no compelling reason to believe that the yuan is substantially undervalued. If anything, the level of unemployment in China suggests that yuan may in fact be overvalued...

Answer 3

China uses a yuan, not a dollar. Do you mean, "peg TO" the dollar?

If you're going to put your homework questions up here, at least get them straight.

Answer 4

well, if they allowed to yuan to float in the international market. the yuan would be undervalued. in essence, the chinese economy would stop growing at the rapid pace we see today. chinese goods would be more expensive and the US would **** its pants. the chinese finance alot of the US debt through government bonds with extra cash they have. thats why US leaders dont really pressure the chinese to let their currency float against the dollar.