Table of Contents
China’s economy has been rapidly growing since 1980s and is considered to be on a trail to outdo the U. S as world’s largest economy in the near future. In regards to this, the management of the Chinese Yuan exchange rate is seen as a crucial factor in the country’s economic policy (Oksanen, 2010). However, despite its global economic position and having ‘biggest foreign exchange reserves,’ China’s currency is pegged to US dollar. Oksanen (2010) explains that China’s currency has been through various exchange rate regimes with recent ones being a ‘managed’ floating exchange rate. This means that the currency was flexible to a certain narrow margin while it had a fixed bas rate which was based on specific ’basket of currencies’ with different weightings.
In the year 2008, China decided to peg its currency against United States dollar following the serious economic conditions it faced during the financial crisis. Pegging refers to a method used by a country in order to stabilize its own currency value by fixing its foreign exchange rate to that of another country (Duarte and Schnabl, 2015). As the financial crisis intensified, China felt pressured to peg its currency from the floating exchange rate to cushion itself against further weakening of its currency and stills operate in the same exchange rate regime. This has since been criticized on the fact that it has led to consistent undervaluation of the Yuan and thus making consumer imports expensive in China. The low value of currency also interferes with the growth of the country’s domestic market due to excess investment on exports rather than the domestic market strengthening (Oksanen, 2010).
Disadvantages of fixed exchange rates
- It is outdated because it was developed to suit the gold standard of the 19th century
- It leads to decreased foreign investment
- It discourages monetary independence – leads to reliance on monetary policies
- It does not reflect the true cost-price relationship because different countries have different economic policies.
- It also causes inflexibilities in international monetary exchange.
- Duarte, P., & Schnabl, G. (2015). Macroeconomic policy making, exchange rate adjustments and current account imbalances in emerging markets. Review of Development Economics, 19(3), 531-544.
- Oksanen, H. (2010). Pegging the Renminbi to a Basket – Facts, Prospects and Consequences. München: CESifo, Center for Economic Studies & Ifo Institute for economic research.