Prepared

by

Diego Chamaca Flores

September 29th, 2015

CASE

THE CHINESE YUAN: BE CAREFUL

OF THE DRAGONS TAIL
1. EVALUATE THE THREE CHOICES THAT CHINA FACES IN
DETERMINING W HAT T O D O W ITH I TS C URRENCY V ALUE. W ICH
CHOICE WOULD YOU CHOOSE, AND WHY?
i.

Widening the Trading Band: This is the option in the short run. This
is the fastest measure that China has. It just might to calm down the
pressures from the international community and specially from the
United States but for a while. The widen of the band can not increase
more tan 2,5 percent above or below par value, and it could give a little
bit more flexibility to the Yuan against the dolar and vice versa. Its
advantage is to stabilize medium-term exchange rate, establishing a
base in exchange rate expectations. This is beneficial for China to
maintain economic stability, but it is not suitable for their
international market relations. This measure is still too rigid in terms
of competition in a more open world.

ii.

Pegging the Yuan to a Bigger Basket: This measure opens more

flexibility to the Yuan allowing to partner currencies to trade with the
Yuan and adding more competitiveness in the monetary international
trading. This may mean the beginning of a more flexible monetary
policy and adaptation to the international market from which should
emerge a more valued Yuan. It also would free the Yuan from relying on
the U.S dlar as its main peg. This would also result in less volatility
because some currencies in the basket might be strong and others
weak. But it is not easy to choose the currencies that make up the
basket, and it is a challenge to select the correct currencies to include in
the basket and to weight rightly between the options and also
determining how much the Yuan would float against the basket.

iii.

Letting the Yuan Float: For most countries in the world to have a
Floating Exchange rates systems is a very good options. There are somo
advantages and disadvantages of having a Floating Exchange Rate:

Advantages:
1) No need for international management of exchange rates

2) No need for frequent central bank intervention

3) No need for elaborate capital flow restrictions
4) Greater insulation from other countries economic problems

Floating exchange rates also have disadvantages:
1) Higher volatility
2) Use of scarce resources to predict exchange rates
3) Tendency to worsen existing problems

Source: Dummies.com

But for China it is not an interesting Outlook. This option is a big risk for
China because there is no way of knowing how much the yuan will rise
against the dlar. If it rises too far, too fast, it could choke off economic
growth in China and crate political and social problems. Also, it might
be difficult for an emerging foreign-exchange market in China to handle
the volatility.

I think that, according to the analysis of these three options, that the
best choice for China is to peg the Yuan to a Bigger Basket bacause it is
less risky, understanding all internal problems into China like
unemployment and that being more open to the Exchange rate market
is a risk for China because the Yuan can decrease in a very big amount
and that would cause and uncertain landscape, economically, then
politically and so forth.

2. ON JULY 23, 2005, CHINA REVALUED THE YUAN BY 2,1

PERCENT. GIVEN THAT THE EXCHANGE RATE WAS 8,2725
PRIOR TO THE REVALUATION, LOOK AT THE EXCHANGE RATE
TODAY. HOW MUCH HAS THE YUAN REVALUED AGAINST THE
DOLLAR S INCE T HEN? D O Y OU T HINK T HIS I S E NOUGH T O T AKE
THE PRESSURE OFF CHINA? WHY OR WHY NOT?
By observing the charts on the web, we can notice the following information:

As we can see, today the dollar against the yuan is 1 USD = 6,3637 CNY

The rate has been going down from 8,2725 to 6,3637 CNY per dolar this is a
devaluationg of almost 33%. In August of the present year China devalued the
yuan again. Just over one month ago the Peoples Bank of China (PBOC)
surprised markets with three consecutive devaluations of the yuan, knocking
over 3% off its value. Since 2005, Chinas currency has appreciated 33%
against the US dollar and the first devaluation on August 11 marked the largest
single drop in 20 years. While the move was unexpected and believed by many
to be a desperate attempt by China to boost exports in support of an economy
that is growing at its slowest rate in a quarter century, the PBOC claims that
the devaluation is all part of its reforms to move towards a more market-
oriented economy. The relative size of the devaluation appears to be in line
with market fundamentals and thus, at least for now, the PBOCs claims can be
believed.
Despite surprising markets and being critiqued for exchange-rate
manipulation, China has a good reason for the recent devaluation of the yuan.
With slower growth in China and a strengthening US dollar, allowing the yuan
to depreciate is in line with market fundamentals. Regardless of the fact that
Chinas exports may get a boost from the deprecating yuan, the move is
consistent with the Chinese governments commitment to let the market play
a greater role in determining economic outcomes.
I think that is not enough for the US to take the pressure off China, even this
revaluation was a problem for China because it made the things more difficult
for the Business and economic environment. This because the US is still with a
high deficit and is still (2015) fighting against the yuan currency.
3

3. USING TABLE 10.1 (PAGE 371), WICH EXCHANGE-RATE

ARRANGEMENT IC CHINA USING NOW? BE SURE TO READ THE
FOOTNOTES.

China has other conventional fixed exchange rate regimes. China adopts more
than one nominal anchor in the management of monetary policy.

The exchange rate of the renmibi is a conventional fixed exchange rate regime.

4.

ASSUME Y OU A RE A C HINESSE E XPORTER. W OULD Y OU P REFER

A CHINESE EXPORT TARIFF ON SELECTED GARMENT AND
TEXTILE EXPORTS AS A WAY TO RELIEVE PRESSURE AGAINST
THE YUAN OR A REVALUATION OF THE CURRENCY? WHY?

If I am a Chinese exporter, then I sell my products and I get paid with dollars,
which I will have to change in the country in order to use them. If it is revalued
the currency then what will be done is increase the relative value of the yuan
on the dollar, something that to me as exporter doesn't suit me, since for every
dollar I get fewer Yuan than before. What would be useful to me in this case
would have a tariff of selected clothing and textile exports, because if I do not
work with these products then not affect me that export tariff, instead of the
currency revaluation affect all levels of exporters and also to importers, but in
the opposite direction.

5.

CHINA HAS THE LARGEST FOREIGN-EXCHANGE RESERVES IN THE WORLD AT

$1.33 TRILLION BY THE END OF THE SECOND QUARTER IN 2007. THIS IS
COMPARED WITH FOREIGN-EXCHANGE RESERVES OF ABOUT $165.6 BILLION IN
2000. WHY DO YOU THINK CHINAS RESERVES HAVE GROWN SO MUCH IN LESS
THAN SEVEN YEARS? HOW CAN THAT LARGE RESERVE POSITION HELP CHINA
MANAGE THE VALUE OF THE YUAN? MOST OF CHINAS FOREIGN-EXCHANGE
RESERVES ARE IN U.S DOLLARS, ESPECIALLY U.S TREASURY BILLS. IF YOU WERE
AN ADVISER TO CHINAS CENTRAL BANK, WOULD YOU RECOMMEND CHINA
CONTINUE THAT COURSE, OR ARE THERE ALTERNATIVES?

According to the text, "the reserves in the central bank" are essential to the
financial strength of a country. There are three types of reserve assets: gold,
currency and the IMF-related assets. This has aimed to protect themselves from
financial crises and that is probably what you want China to increase its foreign
4

exchange reserves to maintain the stability of its currency and not to run the risk
of get down any adversity. Probably, due to the growth of China what is sought is
to have competitiveness at a global level.

Another way of maintaining the stability of the currency is through the active
intervention of the central bank, through the buying and selling of a currency to
affect its price.

The Chinese have the option of investing in other currencies, as it could for
example be the Euro, which would elevate the United States interest rates,
slowing the U.S. economy and reduce demand for Chinese products, negatively
affecting China's economy.

So based on what we have learned, I would recommend China follow in this

direction.