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USD/CNY: Exchange Rates - Essay Example

In other words, Chinese Yuan is not allowed to change its exchange rate according to the forces of demand and supply instead Chinese Government intervenes in the exchange rate market to set the rate it desires. Many experts argue against this policy. They believe that if Chinese government allows the currency market and forces of demand and supply to control the market, the USD/CNY exchange rate will be much higher. Although many economic theorists question the viability of such policy, but it has been proven that the policy has been pretty successful as China is lead the global economy. So much so that even President Obama stated that the Chinese policy of keeping their currency undervalued results in competitive disadvantage for American firms. We can look at the above scenario from the economic theory of fixed exchange rates. Figure 3: Chinese Government Intervention in Exchange Rate Market Source: Sloman, 2004 pp. 235 Figure 1 above shows the how Chinese government keeps it exchange rates at level lower that what it should be. This strategy helps the economy of People’s Republic of China. Chinese firms are more competitive when the exchange rate is lower than when it is higher. ...
This makes sure that the exchange goes down to a level that is determined by the Chinese government. This leads to more exports and improving balance of payment scenario as higher prices of imports discourage people to buy imported goods. Hence, the Chinese government is at an advantage by keeping exchange rates in control. This policy makes Chinese firms more competitive in the international market and leads to more exports and at the same times it discourages imports because imported goods become expensive in local currency. The figure 2 above shows the change in China’s policy after 2005. The Chinese government decided to increase the role of market forces in determining the exchange rate after 2005. In the first stage, the government appreciated the currency from 8.28 to 8.11. This was an appreciation of 2.1%. It was also announced that the exchange rate of USD/CNY will be allowed to fluctuate around 0.5% daily. After this the government appreciated the USD/CNY exchange rate slowly but steadily. In 3 years time from July 2005 to July 2008, the USD/CNY exchange rate moved up from 8.11 to 6.53. The current system can be called as managed floating exchange rate. In this system, market forces are allowed to operate until certain limit (in this case 5%) after which the government starts intervening the market in order to maintain exchange rate stability. Figure 3: China use of “Managed Floating Rate” Source: Lipsey and Chrystal, 2003 pp. 243-248 Figure 4: Chinese Exchange Rate New System Source: Sloman, 2004 pp. 235 Figure 4 above shows how the new Chinese Exchange rate system works. The government allows the market forces to operate until the exchange rate is under certain limit (represented by red region). However, as soon as the exchange rate crosses ...Show more
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Running Head: USD/CNY USD/CNY: Exchange Rates Name University Part A: Background Infromation: Initially China followed a policy of keeping its exchange rate extremely low. However, it soon realized the adverse affects of its policy and started appreciating its currency…
USD/CNY: Exchange Rates
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