Factors That Positively Affect the Yuan

China Currency Analysis

The People's Republic of China is the second largest economy of the world, with respect to the purchasing power parity and nominal GDP. The former has been recorded to be $8.77 trillion in the year 2009, and the latter has been quoted to be $4.99 trillion in the year 2009. The average growth rate of China's economy is 10%, and has been remained so for the past 30 years, which makes it the fastest growing big economy of the world. Construction and industry form 46.8% of China's GDP. 8% of the entire manufacturing output of the world is contributed by China. Major industries of China include the production and mining of steel, ore, aluminum, iron, and coal. The country is also known for manufacturing armaments, machinery, apparel and textiles, cement, petroleum, chemical, food processing, fertilizers and automobiles.

Speaking of the current trends, the influence of China on the world economy was considered to be quite less in until the end of 1980s. During that time, reforms were initiated for the Chinese economy after the year 1978. After the development of the reforms, the county begin to generate steady and considerable growth in consumption, investment and standards of living. As of the year 2012, China was named as a primary importer of raw materials, exporter of consumer goods, and manufacturer of basic goods. Large state enterprises as well as private enterprises are known to dominate the economy of China, meanwhile the former being more dominant. Since the year 1978, hundreds of thousand people have been alleviated from the state of poverty, ye there are millions of people that are considered among the rural population and the migrant workers that are financially challenged. The official statistics of China reveal that poverty rate of the country declined from 53% in the year 1981 to 2.5% in the year 2005. On the other hand, it was recorded in 2009 that as many as 150 million people in China are living $1.25 per day or less (Mallaby and Wethington, 2013).

Since China has already become the fastest growing exporter, the second largest economy of the world, and the largest sovereign creditor, it is evident that currency of China will prove to be the reserve currency of the world soon. Currently, the Chines Yuan has occupied the 13th position in the list of most used currencies in the world that are used for international transactions. As per this view, just as the dollar displaced the British pound during the interwar years, it is expected that Yuan will also displace the dollar, which be a strong blow to the United States interests.

The purpose of this paper is to launch an analysis into the future of the Chinese currency. There are some factors that positively affect it; meanwhile there are others that have a negative effect on the currency. The aforementioned factors will be briefly discussed. Moreover, the current analysis of the currency and how it has the potential to impact its future shall also be brought into limelight. Mostly, an association of the Chinese currency with its economy and foreign exchange activities will be made.

Factors That Positively Affect The Yuan

The first factor that has the potential to affect the Yuan positively is the availability of cheap labor in China. As we talk of the situation today, the population of China has gone up to 1.3 billion. This figure is almost 4 times greater than the population of the United States. The current labor force of China is somewhat more than 800 million. More than 40% of these 800 million workers are still working in the agriculture industry. this implies that more than 300 million Chinese workers are still known to be farmers with low techonology. The aforementioned figure is more than twice the entire workforce of the United States. Therefore, as it is evident China still has a huge source of cheap labor that is yet untapped as compared to most of the other developing nations. The population of China is known to have a much higher literacy rate. For instance, the literacy rate of China is 91% as compared to 61% of India, which makes China a source of highly trained cheap labor as well. The second factor that has been greatly influencing the currency of China, and will keep doing so in the future as well is the resources of China. China has been blessed with a huge amount of natural resources. Mining and manufacturing of ore, iron, steel, and coal is one of the main fractions of the Chinese economy.

Factors That Negatively Affect The Yuan

Hu Jintao, the president of China has said one more than one occasion that China has to shift from a country that is primarily based upon labor driven manufacturing to an economy that keeps its focus on the business discoveries based on knowledge. However, falsified data, fraud, and plagiarism as well as other moral deficiencies have resulted in a reputation of China that describes it as a country with scientific and academic misconduct. A professor of the Penn State University, Dr. Denis Fred Simon has said that the reputation of China of fraud demands the answers pertaining to the overall integrity and credibility of the scientific enterprise in the country, and unfortunately generates negativity into the associated issues pertaining to the safety of the products being produced by China, as well as the reliability of the information that is being generated by China. Another factor that can negatively affect Yuan is air pollution. In the year 2008, China overtook the United States as the emitter of largest amounts of greenhouse gases by volume around the globe. The increase in the emissions of gases in China is mainly because of the reliance of China on coal, which contributes about more than two-thirds of the energy consumption of the country. Moreover, it also adds sulfur dioxide to the environment that leads to acid rains. Such acidic rains fall over more than 30% of China. According to the evaluation conducted by the People's Republic of China, out of 338 cities that were evaluated pertaining to its quality of air has been found to be polluted, either moderately or severely. Heart and respiratory diseases associated with air pollution have now become the leading cause of death in China.

Current Analysis of Yuan

The currency of China, Yuan, has been debated upon for quite some time particularly among the political elite of America, who seem to be pretty upset because of the cheapness of the Yuan. However, it has never really been a source of any ambiguity. Analysts have debated enthusiastically about the actual worth of this currency. On the other hand, the authorities have China have left some room for disagreement as to what the Yuan would be worth. Looking in retrospect, there has always been a strong association between the dollar and Yuan. Just lately, the Chinese currency has been floated with a narrow range. Keeping in mind, the narrow band provided by the central bank, many people are of the view that it would go upwards (Leising and Li, 2013).

Talking of the situation in today's time, nevertheless, the authorities of China have tested the reliability of that assumptions stated above. The central bank, at a meeting that lasted for days that ended on 18th of Feb, stated that it had decided to pull down the value of Yuan, as it was quoted by the Wall Street Journal. The currency has also stumbled from the stronger side of the band to the weaker side. Just within a time span of a few days, the value of Yuan has decreased by 1%. On the 26th of February, the foreign exchange regulator of China was reported as saying that the exchange rate reform meant that there were fluctuations from both sides, and this is what will become the norm.

For the past one year, a different scenario has been applied to the situation. Mostly, the fluctuations in the value of the currency have been two way. At the moment, China is enjoying a sizeable surplus of current account and is still able to attract more investment that is foreign direct, that the investment it is able to provide. On the other hand, other sources of capital flows into the country are considered to be more volatile. However, in the last 3 months of the year 2013, a net value of $22 billion of what has been called the "hot money" has flowed into the country. Most portion of this cash inflow can be attributed as "carry trade." This implies that speculators have resorted to buying the dollar cheaply, and then lent Yuan. This activity led to the escape of capital controls of China in the hope of getting some advantage both from the appreciation of Yuan, and from the higher Chinese interest rates.

The aforementioned has exerted upward pressure on the Chinese currency, which fulfils the designs of the carry traders, and inspires others follow them. Irrespective of the considerable buying of foreign exchange by the central bank, the value of Yuan has risen by 2.8% 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.