South-Western College Publishing - Economics  
Will China Float Its Currency?
Subject Chinese Currency
Topic International Finance
Key Words

Float, Peg, Imports and Exports

News Story

As the Chinese economy becomes a growing source of economic power in the global marketplace, the International Monetary Fund (IMF) is asking China to uncouple the yuan from the U.S. dollar. The tight bond of the yuan to the dollar has been cited as the reason for making foreign goods too costly in China and making Chinese exports unfairly inexpensive. Economically, the relationship between the yuan and the dollar has served to promote Chinese economic growth, so the Chinese government has been reluctant to change it.

IMF managing director Rodrigo de Rato makes the case that it will be to China's advantage to float the yuan. "There should be more flexible currencies, not only for China but the whole of Asia," said Mr. de Rato. The I.M.F. argues that the change would help tame Chinese inflation and cool its overheating economy. A recent IMF report noted, "Risks of overheating have not yet abated…[and that further Chinese monetary tightening would be aided] ….by greater exchange flexibility."

Most major currencies are allowed to float up or down to obtain equilibrium levels based on foreign exchange supply and demand. The Chinese government, on the other hand, pegs the country's currency at 8.28 yuan to the dollar. Many parts of the industrialized world have been pressuring China to float the yuan. Most analysts believe that the move to a flexible exchange rate would begin to bring global currency rates back into balance-the current imbalance has hurt both European and United States' trade balances.

Analyst argue that by pegging its currency to the dollar, China keeps export good prices low, resulting in a flood of cheap goods to the U.S. and other countries. On the import side, the peg keeps the price of imports into China high, effectively choking out competition. In response to growing international pressure, the Chinese government has suggested that they will move ahead with plans to float or revalue their currency, but they gave no date for implementation. U. S. Treasury Secretary John W. Snow said that he told the Chinese "we want the pace to accelerate. We're not satisfied, you know," said Mr. Snow, "but I think we do have to acknowledge [that] progress is being made."

(Updated November, 2004)


How will floating the yuan improve the U.S. trade deficit?

2. Why does the pegged yuan make foreign goods too costly in China?
3. How would floating the yuan help with the overheating Chinese economy?
4. 4. What is the IMF? Can it dictate monetary policy in China or in any other nation? How can it affect monetary policies in developing countries like China?
Source Elizabeth Becker, "I.M.F. Asks China to Free Its Currency From Dollar", The New York Times Online, September 30, 2004 and Elizabeth Becker, "China Promises Currency Shift but Gives No Date", The New York Times Online, October 2, 2004.

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