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Ib Economics Internal Assessment

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Introduction

Ib Economics Internal Assessment Commentary Anton Malyshev 22/01/06 Since 1994, the Chinese Yuan has been pegged to the U.S. dollar (8.28 Yuan/USD); this period has caused the Chinese economy to experience an average 8% annual increase in GDP. In order to sustain the undervaluation of the Yuan (by maintaining the peg), Chinese consumers have to keep their savings artificially high and the government has to intervene by buying out U.S. dollars from the United States daily. Lately, the U.S. has been pressuring China to revalue or float their currency while Chinese economists believe that such an action would cause disastrous effects to their economy. Even though a fixed exchange rate does not violate WTO or IMF rules it disrupts WTO agreements or is used to gain a comparative advantage. It is arguable that China's peg to the USD is somewhat bending the rules if not breaking them. By keeping their exchange rate lower than market equilibrium, China is able to increase the demand and consumption of their exports because all of the exports have to be bought in the producing country's currency. ...read more.

Middle

Perhaps a better parallel of a currency peg can be made by comparing it to a subsidy. A subsidy is the process in which the government pays the producers (usually domestic) to produce less and the loss of revenue from a decrease in production is paid by the government. In this case, consumers who purchase the exports receive benefits but the domestic firms that have to compete against the low-priced import suffer. Having the potential negative effects of the undervalued Yuan in mind, many critics of the peg assume that the trade United States trade deficit with china is caused by the low exchange rate and harms the United States economy. However there are several important things to note on this issue. Firstly, a large amount of foreign investment in China comes from international companies who take advantage of China's cheap labor. Also, besides the fact that the U.S. deficit with China has been growing increasingly, it is also important to keep in mind that China has become one of the fastest growing markets for U.S. ...read more.

Conclusion

What seems most appropriate is floating the currency in order to provide automatic adjustment of the exchange rate to reach market equilibrium. In the long run, the both the U.S. and Chinese economies will benefit. 1 The Economist print edition, Nov. 17,2005 2 Because of the rise in certainty, ceterus paribus, there is an rise in trade patterns of trade in terms of capital and trade integration. Thus the statement, "[Schumers] proposal is justified based on the effective tariff China places on foreign goods via a forcibly undervalued currency" is false. 3 China's Exchange Rate Peg: Economic Issues and Options for U.S. Trade Policy, may 10, 2005, Congressional Research Service-The Library of Congress 4 http://www.msnbc.msn.com/id/8129284/ 5 It is important to note that there is a crucial assumption that is made here. The assumption, and in this case it seems to be fairly true, is that the demand for exports is price elastic because if this is true, then the fall in the price of exports will lead to a proportionately greater increase in quantity of exports demanded. ?? ?? ?? ?? ...read more.

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