Will The Chinese Yuan Begin to Float Freely?

There have been many rumours recently in the media that the Chinese currency Yuan (CNY) will be re-evaluated or even begin to float freely in the near future. In this newsletter, I would like to share my personal view on this controversial topic.

What is the background that has lead to this topic even been debated?
During the global financial crisis of 2008 the USA went into a deep recession while China still maintained an 8% GDP growth rate. As a response to the effects of the global financial crisis the US government begun to impose stricter regulations within the financial system. Whilst at the same time, as a way of diverting the voter’s attention away from the country's problems, began to lay the blame for high unemployment on the huge trade surplus between the USA and China. I believe the real reason unemployment was out of control was due to the fact that Chinese products were selling in US stores at such low prices that US manufacturers had absolutely no way they could compete. The US government then used its influence and the media to exert pressure on China to re-evaluate the CNY.

So what is the real reason behind this huge trade surplus between the US and China?
China's exports comprise mainly of low value added products such as daily necessities and high value added products such as the popular Apple Iphone. The high value added products in particular make up a large portion of china’s total export income. However, even with the manufacture of these high value added products, the factories in china who manufacture them only receive 1-2% of the gross profit. More than 98% of the profit goes back to the big foreign parent companies such as Apple. But when calculating China’s export value, this 'TRUE' export value for China is ignored. Recently, the People's Bank of China (China's central bank) performed a pressure test on these factories based on what would be the likely scenario if the CNY were to appreciate by 5% against the US dollar. More than 70% of them failed the test because their profit margins are too low. Chances for survival for those low value added factories are even more remote under such circumstances.

Is it therefore realistic for china to appreciate the CNY?
Take a moment to envisage what will happen when all daily necessities that are 'made in china' disappear from the shelves of the super markets and are instead replaced with 'local made' products priced at a much higher price? In my opinion inflation would soar and Central banks would be forced to increase interest rates to tackle inflation. Business activities would shrink due to higher borrowing cost with the immediate flow on effect being much higher unemployment as businesses shred jobs. People would struggle to afford even the daily necessities, and the likelihood of them purchasing the high value added products would be close to zero. There would be a very high likelihood that the whole economy would enter a period of stagflation.  The appreciation of the CNY won't solve the problem, in fact it would do the exact opposite in making the situation even worse because it neglects the basic concept of "comparative advantage" in international trade.

So will the Chinese Yuan begin to float freely in the near future?
In my opinion I would emphatically say no! A stable exchange rate of CNY is key to the sustained growth of the world economy.

Regards,
Hao Sun
Trade With Precision
www.tradewithprecision.com

Follow Trade With Precision on: