Repercussions of potential re-evaluation of the Chinese currency on the global economy

Abstract

1China’s economy is in the eye of a storm. While it is ‘the factory of the world’ and has a scorching GDP growth rate (which some believe is unsustainable), it also has a rising inflation problem and has been traditionally practicing intervention tactics to keep the value of its currency down leading to huge trade surpluses with the world’s biggest consumerist economy – the Unites States of America. There are many different theories about the direction in which the economy of China is headed. Some clearly believe that it is a bubble that is going to burst soon. Lately, China has revised some of its policies – it shrugged-off its decade long fixed system of pegging the Yuan to the Dollar in 2005. The Yuan’s appreciation has already quickened this year, rising by an annual rate of 9% since April, compared with only 3.4% in 2006. Goldman Sachs predicts a further 9% rise over the next 12 months. Hong Liang at Goldman Sachs feels that a 10% rise would knock off 1.5% from inflation over a course of the next two years. This would not only help to squeeze inflation, it would also help to ease trade tensions with America, which complains that China's currency is too keenly priced. But the Americans are still not happy. Many mainstream American economists are calling on China to revalue by 20% or more. The Senate Finance Committee was considering drafting legislation that would allow firms to seek antidumping duties to offset the alleged “subsidy” from the undervalued yuan. The bill enjoys wide support and is likely to be passed before the end of the year. In early April the Bush administration filed two more complaints: one on Chinese pirating of DVDs and CDs, and the other over restrictions on the sale of foreign films and music in China. All these examples clearly demonstrate that the sentiment is negative in the US and there is an increasing appetite for tougher action against China.