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China currently maintains a peg of 8.3 yuan to the dollar by purchasing dollars (and selling yuan) every time pressure builds for the yuan to strengthen; by allowing their currency to free float and ceasing its interventions, the yuan would return to its "fair-market" value. Determining the exact figure for a true value is extremely difficult, but almost everyone agrees that the yuan would appreciate if it were allowed to float freely.
A free float would also potentially be dangerous because it could prompt speculators to flood the markets, and easily result in exchange rate overshooting.
A free float of Renminbi anytime in the near future is completely improbable because import and exports represent a high percentage of GDP. China knows that if they float the Renminbi, it will only head in one direction. Speculators will flood into markets, pushing the Renminbi to excessive levels. This will threaten their exports, which has been the foundation for the strength of their economy. With unemployment hovering around 15%, and joblessness rising, China cannot afford to introduce such large business risk to its manufacturing sector. Additionally, a free float is not necessarily good for the US. China is a large owner of US treasuries. They have accumulated foreign exchange reserves in excess of $500 billion. They are currently the second largest purchasers of US treasuries, next to Japan. Hence, they play a pivotal role in keeping US interest rates low, supporting the US recovery. If China floats their currency, they will no longer need to accumulate foreign exchange reserves at such an aggressive pace. In fact, their demand for US Treasuries will fall significantly, which could lead to a back-up in long-term US interest rates and hence, |
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cause a collapse in the bond market, jeopardizing the US recovery. This is mainly because the sum of the nation's current account balance and its net inflows of FDI have been increasing, as have its foreign exchange reserves. A free-float is the most unlikely solution for the Chinese authorities to
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adopt (at least in the short term) because the nation's financial markets aren't mature enough yet. A strong and efficient banking system needs to be created before this option may even be considered. In addition, many economists fear that a sudden removal of any kind of peg might lead to an overly abrupt change in the currency's worth, leading to damaging economic shocks and possibly a recession. |
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