Thursday, July 21, 2005

The government of China has decided to stop its currency peg to the U.S. dollar. The country will revalue its currency, the yuan, for the first time in a decade. This comes after international pressure from Western countries, especially from the United States. The yuan will now be linked to a variety of different currencies.

The People’s Bank of China has announced a 2.1% revaluation increase which will allow the yuan to fluctuate +/- 0.3 yuan in daily trading. This means, like other currencies, that closing prices one day become opening prices the next day.

The U.S. government has been pressuring China to revalue its currency since China joined the WTO. The U.S. said that China has kept the yuan up to 40% under its real value to increase exports, thus giving China an unfair advantage against western industrial competitors as well as industry in developing nations.

Since the announcement the yuan has strengthened to 8.11 yuan to the US dollar instead of 8.28 as it has been for the last ten years. This means the yuan is more expensive and that Chinese goods will become more expensive in western countries.

Economic growth in China might also slow down, but it has been soaring for the last several years. This could have serious consequences in China, but a People’s Bank of China person has said that the exchange rate will be “basically stable”.

China linked the yuan to the dollar in 1997 during the major economic crisis in Asia. This has provided the stability which has allowed the Chinese economy to grow over the last ten years. This move will make China vulnerable to future financial fluctuations.

This move could also mean that the US dollar would fall if China switches from holding dollars to holding for example the euro or other strong currencies.