Dollar-Yuan..what is the buzz all about?

The idea for this blog came after my MicroEconomics class last Saturday. Our professor started of with the microeconomics and moved to the so called Macro part of it telling about the Dollar Yuanbattle, Rupee appreciation and all other stuffs. I think these days almost every one are familiar with these terms and my aim is to throw a light on this to those who are not aware of it and get my concepts corrected from those who know it better.So for all the questions and corrections you can mail me or post here.

So what is all the buzz about Yuan revaluation about?
Before going into the details of the issue I will provide some figures which will help in getting a better picture about the problem.

1 US $=7.61 Chinese yuan, which is a post revaluation high (this happened in 2005 and Yuan closed at 8.11 per US $ that day)
Trade deficit of USA with China last year=232 billion US $

Again there are many arguments for such a big trade deficit.

• The savings rate in China is more than 40 per cent where as in the US it is less than 2 per cent.


• US workers enjoyed relatively high wages but remained excessively engaged in low value-added industries such as textiles and agriculture.


• US policies discriminate against exports of goods that China needs. Restrictions on exports of military and high-technology products to China partly explains Beijing's huge trade surplus with America.

U.S. lawmakers accuse China of holding down the value of the yuan to spur exports, contributing to a U.S. trade deficit with China that's forecast to widen to a record $300 billion in 2007.Some economists in US are telling that Yuan needs to be revalued to atleast 40% (4.5 per $).They are accusing Chinese policy of purchasing US Treasuries and other securities to earn interest and selling yuan-denominated bonds domestically to soak up the excess liquidity these yuan sales create and thus preventing inflation.This increases Chinese savings and transfers purchasing power to, and lower savings in, the United States. And as per them this encourages export industries there, triggers their stock market, where as they stay backward in domestic needs like public transport and sanitation.

What is China doing with all this money?
How China is managing the foreign reserves may surprise one then.Beijing is purchasing dollar and other foreign currencies.Much of it in US Treasuries. There is one more argument that because China invested a bulk of their reserves in US treasury, they indirectly sponsored Iraq war n all.

What if revaluation happens?
Normally one will think that the Yuan revaluation will stir inflation rates in US, its biggest consumer.But an interesting article regarding this came in Washington post 2 weeks back.While American senators and investors are crying for re valuation, the author of the article, Arthur Kroeber spoke of 3 un intended consequences.

• Rise in home mortgage payments: Increase in export earnings will prompt China to reinvest it in US Treasury bonds,which inturn lowers interest rates on bonds and home mortgages.Also China may try purchasing other currencies.Both will result in hike in US increase rates.


• Rise in price of Gasoline: Another interesting observation by Arthur.The increasing purchasing power will make people invest in cars and other transport options as China's public transport is in bad shape.This will drive the oil prices higher.


• China starts to buy up the United States: Say the Yuan is revalued to 30 percent.Everything in US will be cheaper by 30 percent.They will flush with cash in US market.Last time when Japanese yen was revalued,Japanese firms ended up taking stake in US firms.For example,Sumitomo Bank Ltd. of Japan took 10 % stake in Goldman Sachs.
  

So we can expect Beijing trying to balance the exchange rate in a timely fashion to a value that will please the US and other countries as well as maintaining stability in domestic market.

renminbi:Another name for Chinese Yuan. Means People's currency in Chinese