Yen for Yuan China Has

¶ … Yen for Yuan China has a fragile economy that is undergoing a major economic transition. Holding down the value of the yuan allows China's exports to be cheaper than the exports of other countries so that it can maintain low unemployment as its economy evolves from state enterprises to a modern market global production system. Otherwise, large-scale unemployment might lead to political unrest. There is ample evidence that China is intentionally maintaining a weak currency policy to fuel continued economic growth through a favorable trade balance.

Even though the dollar has become weaker, China maintains the same peg to the dollar that it has kept since 1996. As a result, it's seeing abnormally high increases in its foreign exchange reserves, 47% in 2004. The fact that China has to buy up large quantities of dollars to continue to keep the dollar strong against the yuan further illustrates that China is artificially holding down the value of the yuan. By having a weak currency policy.

China can boost economic growth, which keeps unemployment low, drives business and knowledge through China, and encourages Chinese trading partners for future economic growth. All these benefits mean that China can more readily absorb former employees of state enterprises. A weak yuan also helps China thwart deflation because, while a weak yuan lowers the price of exports, it also simultaneously raises the price of imports. Also, China's increase in its money supply serves as a monetary policy to fight deflation by increasing aggregate demand in its own domestic economy.

This tariff would directly cost Americans $55 billion. Many economists view forms of protectionism such as a tariff as merely a disguised transfer payment from consumers to local high-cost producers. For this reason, it would be more beneficial for American consumers to encourage China to engage in freer trader rather than impose large tariffs on Chinese products as proposed by the U.S. Senate. The dollar would depreciate 20% against the yuan. Economists aren't sure exactly how much the yuan in undervalued against the dollar; estimates range from 20% to 30%.

Therefore, it is difficult to determine exactly how significant the depreciatin would be. As the dollar reaches fair valuation with the yuan, the impact would certainly be extraordinary as China loses its unfair price advantages to competing countries like the U.S., Europe, Japan and South Korea. In order to maintain the same peg to the dollar that it has kept since 1996, China has been increasing its money supply to keep the value of the yuan low.

China's money supply has risen from 19.6% in 2003 to 14.6%, a situation that can cause inflation as well as undesirable asset bubbles that would further present the risk of additional bad loans. These are already a problem as state companies and developers have racked up bad debt. If the Chinese government discontinues foreign exchange intervention, the yuan would certainly appreciate given the estimates of its signification undervaluation. However, yuan appreciation would not be a desirable outcome because China is trying to keep its unemployment low through cheap exports.

As a more viable alternative, China could relax its capital outflow policies by allowing overseas investments. Thus, China would not have to sell as much yuan to buy up foreign currency inflows which would.