Abandoning the Dollar Peg Over

¶ … Abandoning the Dollar Peg Over the last several years, China has been actively trying to maintain balanced growth. This is because, the GDP rate is increasing so much that the country has been seeing an improvement in its standard of living and wealth. At the same time, this has also helped to fuel rising amounts of inflation. This is significant, because it is showing how the government is trying to maintain some kind of steadiness in their economic policies.

As a result, they have been slow to allow the yuan to appreciate. The reason why, is because they believe that if they move to fast in one direction (such as: automatically removing the peg against the dollar). That it will create some kind of contraction in the economy. This is the point that exports will decrease and the nation will go through a period of deflation (similar to what is happening Japan).

(Forcing Yuan Appreciation 2011) In the article titled: 27 Up the Implication of China abandoning its Dollar Peg, it discusses the long-term impacts that removing the peg will have on the economy. As the author is looking at, the benefits and drawbacks of this kind of policy on the nation. To determine if this approach is effective we will examine the ideas that are presented in the article and conduct a thorough analysis.

Once this occurs, it will offer specific insights about what will happen to the economy and why Chinese officials have been continuing to embrace their current approach. This is when we will see the true effect of removing the peg against the dollar over the long-term. (Eichengreen 2010) The Ideas that are presented in 27 Up the Implication of China abandoning its Dollar Peg According to the author (Eichengreen), there is one of two scenarios that will happen if the Chinese government were to de-peg their currency against the greenback.

The most notable include: there will be more stable economic growth or the nation will begin to experience a major contraction. These elements are important, because they are highlighting how the two exact opposite scenarios are adding to overall amounts of controversy. The reason why, is because China and its trading partners will have opposing ideas. This increases the amounts of tension, as one side believes that the other is not working fast enough. While the opposition thinks, that they are taking a balanced approach in dealing with these challenges.

This is when there are increasing amounts of controversy and tension over how to resolve the situation. There will be more Stable Economic Growth In the article, Eichengreen (2010) he discusses how the removal of the yuan against the dollar will help to improve economic growth. This is because once this action takes place; it allows market forces to determine the proper rate in comparison with other major currencies.

As, the peg is keeping value inflated at: one set predetermined rate and not accounting for any kind of shifts in the economy. Over the course of time, this can add to overall amounts of pressure on the currency to adjust. When the peg is removed, is when market forces will quickly make any kind of changes. This is the point that economic growth will become more stable. Evidence of this can be seen with the 20 out of 27 nations that have removed their peg against the dollar going back to 1969.

What they found, were that these actions allowed the majority of countries to see steady amounts of economic growth and an increases in the value of its currency in comparison with the dollar. This helped other sectors to develop and balance out those industries that were negatively impacted by the changes in policy. Some good examples of those nations that were positively affected by removing the peg against the dollar are listed in the below table.

(Eichengreen 2010) Country Year Austria 1971 Germany 1969 Denmark 1971 Finland 1971 France 1972 Hong Kong 1972 Japan 1973 Malaysia 2005 Mozambique 2004 Switzerland 1973 (Eichengreen 2010) This information is significant, because it is showing how removing the peg against the dollar will have a positive impact on economic growth in developing nations. Once this occurs, is when the economy will be able to balance itself out by letting the market forces determine fair value for their currency. To corroborate these views, Eichengreen conducted another study.

This time, he wanted to see the net results of the removal of the peg on the economy within one year. What he determined, is that the net effect of these actions were that economic growth remained consistent. As, the total average GDP rate for these nations was 5.6% the year before this took place. During the year after this, is when the number came in at 4.7%. This is important, because it is showing how these actions did not hurt growth in these nations.

For China, this is illustrating why they need to remove the peg against the dollar. As their fears about this having negative implications on the economy are unfounded. Especially, when you consider the fact that nation has been experiencing 11% growth and they have seen limited effects from the global financial crisis. This is a sign that they can remove the peg and it will have little impact on the economy.

(Eichengreen 2010) The Nation will Begin to Experience a Major Contraction An alternative view is that if China removes the peg to fast, there will be a major adjustment in the currency. Once this occurs, is when the nation will go through a long period of economic stagnation. The reason why, is because the peg has been in place for so long that there are a tremendous amount of imbalances. If it is quickly removed, it could cause a major period of adjustment.

This is the point that China may enter a long period of deflation and continuing weakness. To avoid these kinds of issues, Chinese officials have been reluctant to increase the rates of change. Instead, they have been focused on introducing gradual reforms. The basic idea is that this will slowly addresses these imbalances over time and they will ensure that the economy does not have any sudden shocks. Once this happens, is when the government will effectively addresses these challenges.

While at the same time, China is able to maintain consistent levels of economic growth. This is significant, because it is highlighting why the nation has taken a more gradualist approach when dealing with currency issues. (Eichengreen 2010) A good example of this can be seen with any kind of attempts to force them to revalue the yuan such as: the recent bill in Congress. What has been happening; is the U.S.

Senate is considering placing duty on all Chinese goods if they did not remove the peg on the yuan. As China has been criticizing these actions; fearful, that they could spark a worldwide depression. Commenting about what was taking place the Chinese government said in statement, "There were similar circumstances in the 1930s. As, the passage of the Hawley Smoot Tariff Act of 1930; exacerbated a drastic economic downturn by triggering a global trade war of protectionist tit-for-tat measures.

The United States' economy and the world economy are different from those of the 1930s. But looking back on history, this would help the U.S. Senate to see the problems, contradictions and dangers of the currency bill. China has an old saying that one should use history as a mirror to understand the rise and fall of states.

We hope that those American politicians clamoring to force the yuan to appreciate will absorb the lessons of history and head the voices of reason, by not committing to a foolhardy act that will harm their own people and others." (China Media like Yuan 2011) This is significant, because it is showing how China is fearful of dramatically removing the peg on the yuan. As, they believe that it will have a negative impact on economic growth going forward.

(Eichengreen 2010) What Strategy will Work the Best? After examining the benefits and drawbacks of both approaches Eichengreen, believes that most logical policy is for China to remove the peg in series of stages. The reason why, is because there are vast imbalances that have built up. If the peg is removed to quickly, it will result in dramatic shifts in the markets. This is when economic growth could falter and the economy could enter a downward spiral.

Instead, the government needs to take an approach of removing the peg in series of two to three different stages. This is because this kind of strategy, will address the imbalances that are in place. While making certain, that the government can maintain consistent economic growth. Over the course of time, this will address the issues impacting the markets and it will allow the economy to make a smooth transition.