Undervalued Chinese Currency

Chinese currency is one of the biggest issues linked to the US/ China trade relationships.

Chinese currency is not freely traded on international markets, it means that the price of it does not depend on supply and demand, it does not fluctuate. Chinese government simply declares an exchange rate. Chinese have pegged the currency, so that one U.S. dollar buys a little bit more than 8 yuan, but many economists say that if China's currency were allowed to trade freely, it would be worth more.

It is said that Chinese currency is 30-40% undervalued. In fact, this makes Chinese exporting products even cheaper and more attractive for foreign customers. At the same time, it makes the US products more expansive for Chinese buyers. It is good for the US consumers, but very bad for the US producers, who cannot compete with Chinese companies. It has an immense impact on the US economy, since China is the second largest exporter for the United States after Canada. 

The cheap Chinese currency has resulted in a wide trade imbalance between the countries. In 2010, China’s trade advantage with the U.S. was more than $252 billion. http://www.foxnews.com/politics/2011/01/17/obamas-push-china-currency-changes-cost-consumers/

To keep the currency cheap, Chine needs to keep on buying the US treasury bills, thus becoming the largest creditor of the United States. In its turn, this allows the Treasury Department to be able to keep long-term interest rates lower than they would be otherwise, resulting in lower mortgage and credit-card interest rates.

So, if China revalues its currency, it will result in decrease of imports from there to the US, it will probably shorten the trade imbalance between the countries. It will make it easier for the US companies to compete with Chinese which can possibly lead to the increase in the number of goods exported.

BUT  If Chine revalues its currency abruptly, it won’t have to buy so many US treasury bonds, thus the US will have to look for other “investors”. This will cause interest rates to jump upwards which means more expensive credits and mortgages for the US citizens. The US industries may be hurt because spending will go down. Banking and retail industries may also be hurt.

Most of the economists agree that sooner or later China will have to revalue its currency, on which the US government insists. The key issue here is time adjustment. The revaluation has to be done gradually, so both economies are not hurt and continue growing.