US China Currency Relations – The yuan is still too cheap!
The relationship between the United States and China is best described as a love-hate. American’s love Chinese goods and the Chinese love American treasuries but the political tensions are heating up as the new Treasury Secretary is taking a similar stance of Treasury Secretary’s before him– the Chinese currency is being manipulated and kept far too undervalued.
Before 2005 the Chinese currency had been pegged entirely to the US dollar. This peg was said to create huge trade imbalances as the Chinese manufacturing powerhouses would always maintain a consistent advantage over domestically produced goods. By pegging the value of the yuan to USD the Chinese could continue to export billions of dollars in products to the US regardless of the present value of the US dollar.
Pegging is pure and simple manipulation and China moved to correct the issue by instead pegging its currency against its vast foreign reserves. China was able to temporarily avoid any conflict with the United States and its currency gained more than 10% in value. This satisfied US interests for three years, that is until the new treasury secretary Geither took a hardline stance on the issue and declared that China was once again manipulating its currency.
What Geither said may be entirely true. To this date no one knows how China is valuing its currency and what currencies make up the basket and in what denominations. Many economists have suggested that the USD may still remain one of the most important currencies in the basket.
The United States will have to be careful in future negotiations as China is one of the largest purchasers of US debt. China’s treasury holdings allow the US economy to continue growing and consuming, if China were to drop its US holdings now the dollar could fall by as much as 30%.
A drop of 30% could hurt the import value of the US dollar but also make its exports that much more viable. With the US dollar gaining so much value in just the past few months now is the time to play political hardball with the Chinese. The USD is unnaturally expensive and politicians can use this to their advantage by taking on the Chinese right here, right now. Exploit the current USD value to make positive gains for the US economy.
