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"I told president Hu that we welcome China's increasing of the flexibility of its currency. But I also had to say that the Yuan remains undervalued, that there needs to be further adjustment in the exchange rate." Said Obama (Reuters).The China's currency is undervalued by about 40% against the United States dollar. This paper discusses why America wants the Chinese currency to be overvalued, the effect of the overvalued Yuan on the American economy and trade deficit and the US economy.
Reasons why the U.S. wants China to overvalue its currency
Among the pacific nations the United States of America that campaigns of convincing china to allow her currency value to rise against the American dollar. America is not pleased by the slow pace at which the Chinese Yuan is appreciating. The American officials claim that the Chinese currency is below the required level which is considered to be a value for the free market and this hurts the US economy (Forex News). In 2008, the purchasing power parity of china was estimated by the IMF to be 1UD=RM3.798 and china was exporting her goods and services worth 1.2trilion dollars. This shows that china was the second after the EU. According to the IMF, the reserves of china are expected to rise above three trillion dollars by the; end of the year 2011. This shows that the Chinese currency is under evaluated at 6.658 Yuan= 1dollar.the country has made its currency to be very low through the pegging of its currency against the dollar, increasing the supply of its currency and increasing the demand for the us currency. As of the year 2010, China was the leading US treasuries holder and it was a head of Japan and this is a serious threat to the united states of America if china comes up with a decision of writing off the united states debt, the foreign exchange market will be flooded by the American currency and the final result will be a negative effect on the American dollar value. This threat is used by China against the American trade sanctions against it (Rao P).
Also, the undervaluing of the Chinese currency has greatly affected the United States manufacturing sector through the increment of the cheap Chinese manufactured goods supply in the market. This has made the expensive American manufactured goods to fail in competing with the cheap goods in the market. The effect of this is the reduced productivity in America and rise of unemployment rates. This has become a challenging aspect to the Obama's government in its process to deal with the unemployment in America (Rao P).
China's increase of its currency recently
The Chinese government has allowed its currency to appreciate against the American dollar by about 20 percent. This twenty percent appreciation in the Chinese currency value has only translated to a very small increase in the price of the American imports from china. This percentage appreciation is too small since it will not help the United States to fully recover from the severe recession that it has faced since 2007 (The Becker- Posner Blog). Even if there is this increase, there is a slowdown in the Chinese economic growth which could lead to political unrest. CFR's Dunaway says, "China has an 8 percent growth target because it needs that growth level to maintain enough jobs to absorb surplus labor in China's rural areas. Without the labor, you breed conditions for instability," (Wolverson R).
Effect of the overvalued Chinese currency on the U.S. economy
The overvalued Chinese currency would benefit the united states of America by raising the costs of the exports of china and this will in turn help the American business that are facing stiff competition from the Chinese businesses/plants. Also, the United States would be able to make its exports less expensive thus increasing its exports to the large Chinese market. The appreciation of the Chinese will be devastating to America because the Chinese will stop managing their currency and also stop purchasing the American treasuries. They will be forced to sell or get rid of the large amount of treasuries they have and it will be very difficult for the United States to pay back for these treasuries. America will be forced to issue more bonds and its treasury may end up being bankruptcy. China is the US's leading banker, giving it a power. China threatens to sell its holdings when forced by the United States to raise its currency value beyond the 20% percent increase that was done between 2005 to 2010 (Amadeo, K.).
Trade deficit and U.S. businesses and employment
Trade deficit is defined as the difference between exports and imports. The United States trade deficit is one of the greatest threats to the domestic economy that could result to political problems. It is because of the trade deficit that America is experiencing high unemployment. The trade deficit has given the foreigners to buy up the United States because it leads to the increase of foreign owned companies and businesses thus increasing the foreign assets in America. the American unemployment and imports are made to be high because of the overvaluing of the dollar against other big exporters' currencies. These foreign currencies are kept cheap by the purposeful intervention of the governments to promote their domestic growth at the expense of the United States (Morici, P)
The trade deficits have enhance a very slow growth and high unemployment due to the more imports from foreign countries which are characterized by the undervalued currencies such as China. The unemployment in the United States will be high until these countries decide to overvalue their currencies in order to allow the US increase exports and other associated economies. For instance, the greater percentage of the United States trade deficit is with china as it owns a large share of the American debts and businesses. This implies that America is sold to China through the trade deficits profits obtained from the American consumers. The increased trade deficits have coincided with time of crisis in the American manufacturing sector which moch losses in unemployment and problems in picking up to move overseas. The American unemployment is about three million jobs since the year 2000. The American economy has been expanded in the recent years but these lost jobs have not been replaced (The future of the worlds trade organization, pg 69)
The both United States and Chinese business executives and policy makers should come together and agree on the suitable currency values that will ensure a health economic development in both countries. This will deal with the high trade deficits in the United States thus reducing the unemployment rates. To achieve this, other nations should support the US in its efforts to pressure China to overvalue its currency.