Abstract
This study examined the effects of a fixed currency exchange system on China’s economy as well as global growth. The study analyzed the different economic indicators of China and their relation to the fixed currency system. We predicted that this system had an effect on various sectors of the economy and resulted in economic growth which is consistent with recent research on the benefits of a fixed system to the economy. The system has made goods from China cheap hence increased its exports and strengthened its manufacturing industry which has had a positive effect on global economic growth. Despite the United States constantly pressuring China to float its currency, the process cannot be rapid as it may have a negative impact on the country’s economy as well as global growth. The findings suggest that China should maintain its currency value against major currencies for a better economic performance and political stability.
Introduction
Recently, China has been playing a dangerous game with its currency with some moves having the risk of sending the world economy into recession. The economic policies of China have appeared capable of having a major effect on the global economy hence a great concern for investors (Frankel, 2009). Being a major economy in Asia, the currency of China has had growing roles in the continent as well as the world in general. The country has experienced growing challenges and made policy decisions that have often sent shockwaves on the global market (Huang & Shuilin, 2004). The evolution and gradual alterations of the foreign exchange policies of the country have been the major efforts in China’s attempts to promote its currency as a global reserve currency while at the same time claim its position as a leading world economy.
Many of China’s trade partners allow their currency values to float against others. However, China prefers to control its currency policy with strict regulations on all trading activities. The country tries its best to control the Yuan’s daily movements on the forex market. Though China at times announces that it has the intention of floating the yuan, it has not made any serious currency policy changes (Frankel & Wei, 2007). For benefits to the economy of the country, China should maintain its currency value against major currencies such as the US dollar and ignore advises, speculation and even warnings to float the yuan.
Literature Review
China has had a tremendous economic growth rate over the last few years, and this has reshaped the country and the world at large. For the country to have such a growth rate, it needed to change its currency policy for proper handling of various economic aspects the major ones being consumer price inflation and export trade. According to Meissner and Oomes (2009), some countries use a fixed exchange rate system as it would have certain benefits to their economies. Among the major things that caused China’s growth rates was a fixed U.S. dollar exchange rate.
Many countries prefer a fixed exchange rate system for the benefits it has on export and international trade. A country will be able to increase the competitiveness of its goods by controlling local currency and having a low exchange rate. Also, the fixed exchange rate system improves the standards of living of a country and hence boost the overall economic growth (Meissner & Oomes, 2009). The ever-changing foreign exchange can adversely affect an economy as well as its growth potential. By protecting the domestic currency from the changing foreign exchange rates, governments have a chance of reducing the occurrence of a currency crisis.
China began to peg its currency to the U.S dollar in 1994 until July 2005 (McKinnon, 2007). When there was increased pressure from its international trading partners, China decided to shift to a managed peg system thus allowed its currency to appreciate until 2008 (Frankel, 2009). After three years with the country having a semi-floated currency, it decided to revert to a fixed exchange rate system. Such an action was due to the 2008 global financial crisis. Reverting to a fixed system had a positive impact on the Chinese economy as it got out of the crisis relatively unscathed.
The main reason that has made China shun away from having a floating exchange rate as its international trade partners is the economic benefits that come with an undervalued currency. When a country has an undervalued currency, then it means that exports are relatively cheaper while imports are relatively expensive (Cendrowski, 2015). China with its managed peg system allows it to have a higher growth rate due to its exports. The reason for this is that goods from the country are appealing to the international market. In turn, this creates more jobs for the Chinese workforce. According to McKinnon (2009), the higher economic growth rate is not the only reason why China prefers the peg system as this system also leads to lower inflation and as a result increased investment.
Research Objectives
Methods and Analysis
The method for the research was through analysis of the effect of a fixed system on various sectors of the economy. By looking at various sectors of China’s economy with and without a fixed currency exchange system, we were able to obtain a clear picture of how the system affects the country as well as other countries. We looked at the economic growth rate of China since 1978 up to date. China began to become a global economic powerhouse in 1978 after Deng Xiaoping brought new economic reforms (Allen, Qian & Qian, 2005). From 1980 to 2010, China was able to have an average of 10% GDP growth rate hence removing a large number of people out of poverty (Allen et al., 2005).
The rapid growth rate of China has mainly been as a result of the export power they have attained over the years. The United States takes a large portion of these exports. China took this opportunity to manage its currency exchange policies so as to benefit its exports. Rather than having a floating exchange rate controlled by market forces, China pegs its currency to major currencies such as the U.S. dollar (Eichengreen, 2004). By China keeping its currency at a low level, it can make its exports more competitive in the international marketplace.
China’s controlling of its currency has brought about opposing viewpoints. The country views that making its exports competitive is one of the ways that it can achieve long-term economic growth. As a result, China has been able to oppose the calls consistently to appreciate its currency among other major countries as it would lower exports and hence economic growth prospects (Eichengreen, 2004). A reduced economic growth rate would have other impacts on the country such as political instability.
Overall, the effects of the currency policy of China is not a simple thing. On one hand, China’s undervalued currency makes U.S. consumers have access to cheap and abundant exports which leads to reduced expenses and cost of living (Funke & Rahn, 2005). On the other hand, the devalued currency of China makes exports by the United States into China quite expensive. In turn, this limits the United States’ export growth and may result in a widened trade deficit. It is clear that an abrupt revaluation of China’s currency would make Chinese exports uncompetitive. Though this may improve the United States’ trade deficit with China, consumers will have no choice but to source many of the products that they need.
Conclusion
The results of this research provide interesting insights into the effects of the fixed exchange rate system on both the economy of a country as well as the world economy. The effect on the world economy depends on the economic power of the particular country which uses the system. This study will contribute to people knowing the merits and demerits of the fixed exchange system. Trade partners should know that a rapid appreciation of China’s currency may have some negative effects on the world economy. First, it would make exports from the country expensive, and the eventual costs of the goods the country produces will be passed to the consumers. Secondly, when the Yuan gets stronger rapidly, it would imply that the manufacturing industry in China would slow down and hence make the country weaken which will have an eventual effect on the global economy. The mixed results of the research show that countries have to learn more about the effects of currency control on other countries.
Recommendations
China should maintain its currency value against major currency to allow for its economic growth, political stability and promote global economy recovery.
China should maintain the status quo because even though there may be no adjustments to the nominal exchange rate, after some time, there would be an adjustment of the real rate when there is a divergence of inflation rates of the United States and China.
References
Allen, F., Qian, J., & Qian, M. (2005). Law, finance, and economic growth in China. Journal of financial economics, 77(1), 57-116.
Cendrowski, S. (2015, August 11). Here’s Why China Devalued its Currency. Fortune. Retrieved from http://fortune.com/2015/08/11/why-china-devalued-yuan/
Eichengreen, B. (2004). Chinese currency controversies.
Frankel, J. A. (2009). A new estimation of China's exchange rate regime. Pacific Economic Review, 14(3), 346-360.
Frankel, J. A., & Wei, S. J. (2007). Assessing China's exchange rate regime. Economic Policy, 22(51), 576-627.
Funke, M., & Rahn, J. (2005). Just how undervalued is the Chinese renminbi? The World Economy, 28(4), 465-489.
Huang, H., & Shuilin, W. (2004). Exchange rate regimes: China's experience and choices. China Economic Review, 15(3), 336-342.
McKinnon, R. (2007). Why China Should Keep Its Dollar Peg*. International Finance, 10(1), 43-70.
Meissner, C. M., & Oomes, N. (2009). Why do countries peg the way they peg? The determinants of anchor currency choice. Journal of International Money and Finance, 28(3), 522-547.
