The Yuan conundrum

The US is accusing China of artificially depressing the value of the Yuan. They said that China uses this to gain a competitive advantage on the world market for its exports. The more hawkish congressmen even alleged that China’s cheap export is causing job losses at home. The US manufacturers are unable to match China on the price of their produce.

So, is the Yuan really undervalued? The answer is probably yes. By how much is anybody’s guess? But, one thing is clear. A revaluation of the Yuan will in no way solve any of the US economic woes.

For China, the constant pressure from the west on its exchange rate is a big bugbear. How can it engineer a strategy and will pacify the rest of the world and at the same time not cause civil strife and economic slowdown in the country.

China has a foreign reserve of about $2.65 trillion. Of this, about 65% is held in US dollars. If China were to revalue its Yuan, then it would suffer a huge loss on its dollar holdings. If it decides to sell dollar to buy Yen or Euro, it would depress the value of the greenback. This would again result in losses for China.

The only way out is for China to revalue its Yuan slowly. Agradual increase in the value of the Yuan will result in higher household consumption. Exports will be affected slightly. On balance, the lost of foreign consumption would be compensated by domestic ones. This would have minimum impact on employment.

China cannot act in haste because of the foreign pressure. If it revalues too quickly, exports would be badly affected. This would force exporters into bankruptcy or move abroad. Workers would lose their jobs and their aggregate household income would drop. This would result in reduced domestic consumption. That would be the dreaded double whammy for China.