Currency Undervalued?

Question

I keep reading that China's currency is "undervalued". What does that mean? How can a currency be undervalued?

Answer 1

The Chinese currency is pegged to the dollar (constant exchange rate). If it were floating like most currencies their trade surplus with the US would cause their currency to rise vs $ to make their product more expensive in the US and US product cheaper there. That is it should be worth more so it is said to be undervalued..

Answer 2

Currencies trade against other currencies on public exchanges, which is how we get exchange rates at any given moment. The "true value" of a currency would be whatever it is on the free market of the currency exchanges -- without the interference of any government.

People accuse China, Japan, and sometimes other countries of manipulating their currencies. This happens when that government's central bank joins in the market, and trades its own currency solely for the purpose of affecting the exchange rate. Example, if the Japan central bank SELLS Yen to BUY US Dollars, this will tend make Yen cheaper and US Dollars higher. (Japan might do that, because a lower currency makes its goods cheaper in international trade, and therefore helps exports).

In the old days there were set exchange rates. But today millions of people trade currencies at whatever the market rate is, so the only way a government can "fix" the value of the currency is by buying or selling it like crazy into the markets.

If a country is suspected of persistently doing that, then people say they're manipulating the market to keep their currency undervalued (which is the usual complaint).