China revalued the yuan in July by 2.1 percent and scrapped its peg to the dollar in favor of a basket of curr

Question

China revalued the yuan in July by 2.1 percent and scrapped its peg to the dollar in favor of a basket of currencies.What does it mean?

Answer 1

Countries either have a "floating" or "fixed" currency regime, which means that either their currencies move or do not vis-a-vis other countries' currencies.

China has historically had a fixed currency, which has not been freely convertable into other currencies. China's historical peg of 8.28 to the US dollar was removed in July of 2006. The Chinese government said that the peg was removed in favor of a "basket of currencies". However, the basket was never defined and in reality, either doesn't exist or is grossly manipulated.

Currencies, when not pegged, can be highly volatile - dependent upon economic forces like trade balances, budget balances, interest rates, productivity and other factors. Each one of these factors can be quite volatile individually and as a group can have considerable swings.

There is something call "interest rate arbitrage", which means that current currency rates, interest rates and currency futures markets all have to move together otherwise you can make free money (e.g. borrow at a specific interest rate in current currency rates and pay back in future currency units if the currency futures factor in a weakening more than the interest rate). All three can move a little, two can move more or one can move alot - but the three have to stay in alignment.

The issue here is that China has "engineered" a 2% appreciation of the RMB per year, kept interest rates stable and futures factor in a 2% appreciation as an almost straight linear relationship. No free currency market is that predicable. The market is implicity agreeing that the market is still very much managed by the central government. The Chinese are depreciating their currency by 2% per year to take some ease off of the massive current account surplus and trade surplus. Without it, China has about US$350b dollars worth of US dollars flowing into the country through trade (US$200b) and foreign investment (US$150b). China buys some raw materials (e.g. oil, iron ore, et cetera) in US dollars, but still has a net massive inflow. If everyone is buying RMB, selling US dollars - the RMB should appreciate (i.e. a change in supply versus demand). However, the 2% is way out of whack with what the money supply is like. China's December M2 (broad money supply) is growing at 16.9%, which is a tidal wave of liquidity in the market. This is a benchmark for how strong the economy is, fueled by this money inflows (primarily from dollars into RMB).

So, the bottom line is that this "means" there is 1) now some flexibility into the Chinese currency system, 2) there is still lots of control put on the RMB and 3) the RMB is still fundamentally undervalued (should appreciate by much more than 2% per annum).

Answer 2

relies upon on whose concept you're following on the economic crumple One is that western international locations have economies that strengthen at 3% a year, although investment strengthen has grown at 6% a year. the effect is that additional money has been invested interior the economic equipment that folk can get returns on. So the present economic downturn is approximately an investment bubble, no longer appropriate to the inspiration of the economic equipment. what is going to ensue is that greater of that investment capital will head to Asia the place strengthen is above 6%. The readjustment of the fee of the chinese language forex will shrink the choose to take a place in China, yet in addition strengthen the fee of chinese language products and shrink the fee of imported products into China. interior the long-term this could be helpful for the international economic equipment.