Factors That Positively Affect the Yuan Research Paper

  • Length: 12 pages
  • Subject: Economics
  • Type: Research Paper
  • Paper: #77738730

Excerpt from Research Paper :

8% as compared to the dollar in the start of the last year to January this year. The value of Yuan has improved even with the fall of other emerging economies. The loss of competitiveness that resulted can be best demonstrated by a ratio that has been calculated by the Hong Kong Monetary Authority, which makes a comparison of Yuan with the currency of the other emerging markets that are in competition with China. It is important to note here that the competitors of China are the countries that trade against it, and not necessarily the countries that trade with it. The index calculated by the authority demonstrates that Yuan has been rising over 13% in the year to January. As for January alone, the value of the Chinese currency has risen by 2.6%.

The authorities of China have not said that they had made a move in to weaken the Chinese currency. However, the intervention made by the authorities have left fingerprints all around the foreign exchange market. In order to weaken the Chinese Yuan, dollars were bought by the authorities to put a surplus of Yuan into the monetary circulation. A fraction of this surplus of money was withdrawn through the selling of securities to the banks. However, the banks still had a surplus of Yuan, which they even tried to lend to one another. This activity led to a decrease in the interbank interest rates, irrespective of the withdrawals of the central bank. As the Societe Generale's representative Yao Wei has indicated that apart from the foreign-exchange intervention, there is no other factor to explain that.

The main question that arises here is whether or not the slide in Yuan will persist. The foreign-exchange regulator, in his statement, indicated that the foreign-direct investment and export earnings must stay strong. The aforementioned basics are suggestive of the rise in Yuan again. However, by making the speculators see something that does not exist; the authorities are hoping that the chance of appreciation of the Chinese currency will not in fact be the cause of the appreciation in the currency.

During the meeting in which the decision of decreasing the value of Chinese Yuan was made, the central bank also made the decision to the trading band of Yuan towards the end of this year, according to a statement that was quoted by the Wall Street Journal. Central Bank hopes to get a freer hand, with a more flexible Yuan, pertaining to setting of the monetary policy, even if it slowly allows the greater flows of capital across the border. Irrespective of its harsh behavior towards the carry traders, the central bank appears to be enthusiastic to allow the inflow of foreign capital with a greater band, as long as foreign investors do not try to intervene in the workings of the bank. This is what will make the currency of China subjected to lesser amount of controversy.

The Future of Yuan

The fact that Yuan will overthrow the Dollar in the future has gained a firm footing since the Chinese leaders have initiated a determined attempt to internationalize their currency, Yuan. During the G-20 summit that took place in the year 2008, when the financial crises were at their peak, the president of China Hu Jintao urged for "a new financial order, internationally, that would be inclusive, just, orderly, and fair." Soon after the summit, Beijing started to encourage the use of Yuan in international trade, change arrangements among central banks, and bank bonds and deposits issuances in Hong Kong. In the first half of the year 2011, the trade transactions that were settled in Yuan added up to almost $146 billion, which was considered to be an increase by 13 folds, as compared to the same period during the year 2010. By mid-2011, the deposits of Yuan totaled up to $85 billion, which can be considered an approximate ten-fold increase since the aforementioned statement made by Hu in the year 2008. It is interesting to note that Yuan is already accepted in financial transactions in the Pakistan, Mongolia, Vietnam, and Thailand (Hefeker & Nabor, 2002). The authorities of China have pointed out that as soon as the year 2015, they want the Chinese currency to become a part of the collection of primary currencies that determine the worth of Special Drawing Rights, which is the reserve asset that has been issued by the International Monetary Fund. On the other hand, Beijing has proclaimed its intention of transforming Shanghai to an international financial center by the year 2020 (Kent, 2013).

Another aspect that needs to be discussed with respect to the future of the Chinese currency is the fact that the dollar is also quite vulnerable. Foreign currency reserves are traditionally held by the central banks, in order to ensure that their ability to purchase imports is intact. However as we speak of today, most of the imported goods all around the world are purchased from China rather than from the United States. Moreover, another reason why reserves are held by central banks is that they want to ensure their ability to pay their debts to the foreign investors. Still, such transactions cause an increase in the flow of capital to China, and even though the lending of China is mostly done in dollars, dominant creditors have the potential to urge on lending in the local currency, the Yuan. Further making matters worse for the dollar, which is resulting in a further depreciation in its value instead of getting stored, as any reserve currency is expected to do. When measured against the currencies of the primary trading partners of the United States, the dollar has lost one fourth of its worth since the introduction of the floating currency system in the year 1973. Over the past 40 years, the dollar has lost four fifths of its buying power when measured against a package of consumer goods. Needless to say, this decrease in the value of the dollar causes nervousness among the central bankers of the emerging economies, especially pertaining to the holding of dollar reserves (Yang, Zhang & Tokgoz, 2012).

Even still, the narrative of emergence of the ascendance of Yuan has mostly proved to be wrong. The international increase in the currency of China will be slower than how it has been predicted, and the Chinese currency is most probably going to occupy a place among the secondary currency reserves, which include the yen, the euro, the British pound and the Swiss franc, rather than displacing the dollar and becoming the dominant currency itself. On the other hand, it is not even certain that China wants its currency to replace the dollar. The step taken by Beijing towards the internationalization demonstrates not a completely formed, rational long-term strategy but rather a developing process formed by disagreements among the policymakers of Chinese authorities over the speed and scope of the financial reform. Far from the confirmation of the rise in Yuan's value, which is inevitable, the uncertain effort of China to internationalize the Chinese currency has revealed the great struggles that are there behind the larger push of the country to change its economic model (Mallaby & Wethington, 2012).

The Reluctant Rise of the International Currencies

Financial analysts might assume that as an economy approaches the status of great power, it is natural for it to make take steps towards the internationalization of its currency. In fact, emerging powers have often done the opposite of what has been stated above. Jeffrey Frankel, the economist has revealed that this is what the United States did during the interwar period and what Japan and Germany did during the 1970s, although the currencies of the aforementioned countries later on were internationalized. In every one of the cases of the emerging economies, both the policymakers and the public were at first skeptical of the advantages of making their currency to be used extensively abroad.

There are two main reasons why the emerging economies fear the internalization of their local currencies. The first factor that fears them is that of competitiveness. When foreigners purchase and hold a currency, the value of the currency increases. The appreciation keeps on happening as long as the purchasers are patient with respect to the currency as a reserve of their wealth. The exports of a country are hurt by a stronger currency, since the goods of that country become more costly in the other countries, which leads to increase competition by the domestic companies that produce the same products at a cheaper rate for the consumers.

Another reason why countries fear the internationalization of their currency revolves around the control of their financial system. Just like China today, Japan, Germany, and the United States all became trading powerhouses at a point when the regulation of their financial systems was quite strict. Interest rates were capped by the governments on…

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