Chinese Yuan will stay fixed

A report yesterday from China Daily, a Chinese national newspaper quotes China’s Premier Wen Jiabao about his plans for the globally important Chinese Yuan currency. The Premier said that China will not change how the Yuan is valued. He said that even though western countries are pressuring China to revalue the currency to more correctly reflect its true value, he said that they are trying to curb China’s development and that is not in China’s interest.

If what I just said sounds like Chinese to you (assuming you don’t speak it) then don’t worry, I will explain it in simpler terms and I will discuss why it is important.

The Chinese government does not allow its currency to float like other major currencies, where the market decides whether it will go up or down versus other currencies. Instead, the Chinese Yuan is pegged to the US Dollar. Today, 1 Chinese Yuan is worth a little less than $0.14 USD. This, by all accounts is way to low. So, when it is said that the Yuan needs to be revalued, they mean that it should be allowed to float like other major currencies, which will increase its value against the USD and other currencies significantly.  The reason China is doing this is because a low Yuan means that Chinese goods are cheaper and thus more attractive for importing into the US and other nations. This is crucial for China as it largely depends on exports to fuel and continue to grow its emerging economy.

For developed nations, especially the US, it is better (not to mention more fair) to let the Yuan float like other currencies. If this were to happen then, US debt which has been in the news a lot lately for being to high would come down as China holds a lot of that debt. Also, it would make other countries more competitive in all industries and would narrow that gap between how cheap Chinese made goods are compared to locally made goods. Chinese goods would still be cheaper for the most part because of labor costs, but it would not be as extreme as it is with a pegged Yuan. To try to persuade China to let the Yuan float, many trade restrictions have been implemented by the US and the European Union on various goods. For now though, it isn’t working as China does not seem to be budging. They likely do close the gap a little but these restrictions alone will not close the gap nearly enough.

If China changed its policy and suddenly allowed the Yuan to float then you would instantly see a much quicker economic recovery in the west and some of the US debt talk would subside. There are those that even argue that the upside to the western countries would be so big that it would override the downside the Chinese economy would feel and would actually improve China’s economy overall instead of hurt it. It is difficult to determine if this is true without trying it out, although it is clear that at least for now, China does not agree with that argument.