China and the Esquel Group
China and the Esquel Group In response to criticism of it pegging the Yuan to the US dollar, China recently implemented steps toward liberalizing its exchange rate policy; however, a floating Yuan has created uncertainty concerning its impact on China’s economy. While it is likely that allowing the Yuan to appreciate against the US dollar will result in undesirable impacts for China such as deflation, a reduction of foreign direct investment (FDI), and a decline in exports, we believe China will, and should, continue a tempered liberalization of its exchange rate policy. This is necessitated by the potential consequences China faces both politically and economically by not moving towards a floating rate.
…show more content…
When the dollar fluctuates, the only way China can maintain the value of its foreign reserve portfolio is by purchasing more dollars, which only further increases its risk and dependence on devaluing the Yuan. This is an expensive practice and has prevented China from being able to make deeper investments in its own economy. We believe that by moving towards a floating exchange rate, China could make these domestic investments, which when coupled with exploiting its massive workforce, including the 200 million unemployed rural populace, it will not only blossom China’s domestic economy but will also allow it to further increase its global competitiveness. China would then be able to promote price stability, thus increasing its central bank’s reputation, in turn causing foreign direct investment to return. This would increase living standards, wages, and consumption, thus boosting GDP. While it may seem logical for China to move towards a floating interest rate sooner rather than latter, it is much easier said then done. It is our assessment that Zhou Xiaochuan was correct when he stated, “Step-by-step reform is a better way of reform.” The vast amount of China’s foreign reserves as well as its overwhelming dependence on foreign exports cannot be easily overcome. In order to avoid a global economic shock, China must commit to a tempered and transparent