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China¶s currency manipulation remarks by Mr. Tim Geithner hit the front pages of all major newspapers last
week. So let¶s take a look at how China manipulates it currency.

To be fair to China, almost every country in the world u
  its currency. In an ideal free market world ±
there would be no government intervention in the currency markets. However, there is hardly any Central Bank
in the world that doesn¶t intervene, when its currency starts to appreciate or depreciate beyond a certain price
band.
Almost every Central Bank has a certain price band for its currency in its mind, and as soon as the currency
goes beyond that band, governments start intervening in one way or the other.

This government intervention can be direct or indirect.

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China has been interested in keeping the Yuan (Chinese Currency) undervalued relative to the US Dollar, and
the easiest way (if you can afford it) to keep the Dollar price high, and the Yuan low is to buy dollars from the
open market.

A country like China, which runs a huge Trade Surplus can afford to buy dollars in the open market to keep the
demand for dollars high, and push the dollar price upwards relative to the Yuan. This keeps the Yuan
undervalued.


 

   
China¶s engine of growth is exports. The lower the value of the Yuan, the better it is for China¶s exporters.
Basically, if 1 Dollar buys 7 Yuan¶s, and a exporter sells a Chinese Shirt for 10 dollars ± he pockets 
.
But if one Dollar was worth only 5 Yuan¶s, the exporter would only be able to pocket 



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It is really impossible to tell by how much the Yuan has been undervalued, but estimates suggest that this range
is between 15% ± 40%.

A direct consequence of keeping the local currency undervalued is inflation and since China faced rather high
inflation rates in 2008 ± it did plan to let its currency appreciate in 2008 (but that was before sub-prime).






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It can be argued that the US is flooded with cheap imports from China not because China is really cost ±
competitive, but because China has artificially kept its currency undervalued. If the Yuan was allowed to
appreciate ± Chinese imports may no longer be cheap enough to compete with American produced goods.

On the other hand, it could really be that the Chinese are cost competitive, and it is really cheaper to produce
goods in China than it is to produce them in US.

The truth probably lies somewhere in the middle.

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The US runs huge trade deficits, and has plans for massive stimulus spending. The deficits mean that this
stimulus spending can be done by either issuing more debt to foreign countries or printing more dollars.

If Mr. Geithner¶s comments continue; they may aggravate China to such an extent that it stops showing up at
the Treasury bond auctions.

If that happens, then the US will have to resort to printing currency and quantitative easing on a scale that
unleashes massive inflation.