T Nation

Why Would Chinese Nationalists Want a Fixed Exchange Rate?

Could somebody explain this to me, and I think it may in turn be instructive to all.

I read “Chinaâ??s currency moves wonâ??t satisfy lawmakers for long. With imports
on the rise and businesses hobbled by the recession, the yuanâ??s crawl wonâ??t cut it. Chief proponent Sen. Charles Schumer (D-NY) will insist that currency manipulation be deemed a trade subsidy, spurring import duties. But punitive legislation will backfire. Beijing would immediately revert to a fixed exchange rate. Plenty of Chinese nationalists already want that.”

Who decides and governs official exchange rates?

What benefits does China get with a fixed exchange rate? The only thing I can see is if the Yuan was going to fall off further, then they would want the guarantee of a fixed value.

Official exchange rates are governed by the international market. Mostly large investment banks that trade in currencies. Unless the currency is fixed, where a variety of macroeconomic tools are used to ensure that the two money supplies remain pegged relatively close together.

EX: 7.78HKD = 1 USD.

At a fixed exchange rate, they probably mean they’d fix the exchange rate at what it is now, where it is currently undervalued, and this helps them undercut other foreign competition for the American Market.

A low-value Yuan helps chinese goods stay low-priced, which helps America keep buying them, which helps China fuel its economic growth.

[quote]Otep wrote:
Official exchange rates are governed by the international market. Mostly large investment banks that trade in currencies. Unless the currency is fixed, where a variety of macroeconomic tools are used to ensure that the two money supplies remain pegged relatively close together.

EX: 7.78HKD = 1 USD.

At a fixed exchange rate, they probably mean they’d fix the exchange rate at what it is now, where it is currently undervalued, and this helps them undercut other foreign competition for the American Market.

A low-value Yuan helps chinese goods stay low-priced, which helps America keep buying them, which helps China fuel its economic growth.[/quote]

Good, solid, short and sweet explanation. Well said.

Could someone explain, or post a link explaining, in brief, how they peg the currency?

[quote]tmay11 wrote:
Could someone explain, or post a link explaining, in brief, how they peg the currency?
[/quote]

The Chinese government simply states they will buy/sell unlimited quantities of currency at a specific rate, e.g. the rate of 7.78HKD = 1 USD.

So if you have 1000 USD the Chinese government will give you 7780 HKD. Likewise if you have 7780 HKD the Chinese government will give you 1000 USD.

[quote]phaethon wrote:

[quote]tmay11 wrote:
Could someone explain, or post a link explaining, in brief, how they peg the currency?
[/quote]

The Chinese government simply states they will buy/sell unlimited quantities of currency at a specific rate, e.g. the rate of 7.78HKD = 1 USD.

So if you have 1000 USD the Chinese government will give you 7780 HKD. Likewise if you have 7780 HKD the Chinese government will give you 1000 USD.[/quote]

I think it’s a little more involved than that. That’s what Vietnam does, but the black market price for dollars in Vietnam is a lot higher than what the government is willing to pay (we’re talking like, 10-15% difference). I think there actually has to be an adjustment in the supply of currency to match the pegged currency. For example:

America’s monetary supply increases by 4% in the year 2010 (hypothetical example). The Hong Kong SAR Government sends notices to the three main banks that have a license to print money in HK to print 4%x(exchange rate) Hong Kong dollars (to make the supply of Dollars and HK Dollars match up).

Alternatively, there’s some magic with the purchase of treasury bonds. I don’t know the specifics though, and would actually really appreciate it if someone could explain in more detail.

[quote]Otep wrote:

[quote]phaethon wrote:

[quote]tmay11 wrote:
Could someone explain, or post a link explaining, in brief, how they peg the currency?
[/quote]

The Chinese government simply states they will buy/sell unlimited quantities of currency at a specific rate, e.g. the rate of 7.78HKD = 1 USD.

So if you have 1000 USD the Chinese government will give you 7780 HKD. Likewise if you have 7780 HKD the Chinese government will give you 1000 USD.[/quote]

I think it’s a little more involved than that. That’s what Vietnam does, but the black market price for dollars in Vietnam is a lot higher than what the government is willing to pay (we’re talking like, 10-15% difference). I think there actually has to be an adjustment in the supply of currency to match the pegged currency. For example:

America’s monetary supply increases by 4% in the year 2010 (hypothetical example). The Hong Kong SAR Government sends notices to the three main banks that have a license to print money in HK to print 4%x(exchange rate) Hong Kong dollars (to make the supply of Dollars and HK Dollars match up).

Alternatively, there’s some magic with the purchase of treasury bonds. I don’t know the specifics though, and would actually really appreciate it if someone could explain in more detail.[/quote]

Ya, from what I have gathered it has lots to do with the government holding U.S treasury bonds. This is what I would like explained.

[quote]Otep wrote:
I think it’s a little more involved than that. That’s what Vietnam does, but the black market price for dollars in Vietnam is a lot higher than what the government is willing to pay (we’re
talking like, 10-15% difference).
[/quote]

True. But it is the simplest and easiest method. Changing the actual money supply is more complicated and prone to error.

[quote]Otep wrote:
America’s monetary supply increases by 4% in the year 2010 (hypothetical example). The Hong Kong SAR Government sends notices to the three main banks that have a license to print money in HK to print 4%x(exchange rate) Hong Kong dollars (to make the supply of Dollars and HK Dollars match up).
[/quote]

Isn’t this handled by the government changing the bank reserve requirements allowing the banks to loan more rather than simply giving them a license to create money?

[quote]Otep wrote:
Alternatively, there’s some magic with the purchase of treasury bonds. I don’t know the specifics though, and would actually really appreciate it if someone could explain in more detail.
[/quote]

I’d be interested to know too. I’m guessing you aren’t simply talking about the government creating more treasury bonds and “sucking up” the currency when they are purchased.

This is very complicated, but we have to try and make it simple.

If a government wants to keep a currency pegged to the dollar they have to manipulate the currency market. The government of China is getting a lot of dollars from trade so it is pretty easy. They can take the dollars out of circulation by buying US treasury bonds/notes/bills, or they can throw those dollars into circulation by selling dollars for other currencies. Both avenues will cause their currency to flucuate. If we stop buying chinese goods, they will be forced to sell the US bonds/notes/bills to get currency to keep their currency pegged. Once the money dries up then there is no way for them to peg their currency to ours without going into debt to do it. If I was the Chinese Government I would do exactly what they are doing. It is in the best interest of China to keep their currency stable. It keeps people employed and pacified so they will not riot or try and over throw the government.

[quote]Otep wrote:

[quote]phaethon wrote:

[quote]tmay11 wrote:
Could someone explain, or post a link explaining, in brief, how they peg the currency?
[/quote]

The Chinese government simply states they will buy/sell unlimited quantities of currency at a specific rate, e.g. the rate of 7.78HKD = 1 USD.

So if you have 1000 USD the Chinese government will give you 7780 HKD. Likewise if you have 7780 HKD the Chinese government will give you 1000 USD.[/quote]

I think it’s a little more involved than that. That’s what Vietnam does, but the black market price for dollars in Vietnam is a lot higher than what the government is willing to pay (we’re talking like, 10-15% difference). I think there actually has to be an adjustment in the supply of currency to match the pegged currency. For example:

America’s monetary supply increases by 4% in the year 2010 (hypothetical example). The Hong Kong SAR Government sends notices to the three main banks that have a license to print money in HK to print 4%x(exchange rate) Hong Kong dollars (to make the supply of Dollars and HK Dollars match up).

Alternatively, there’s some magic with the purchase of treasury bonds. I don’t know the specifics though, and would actually really appreciate it if someone could explain in more detail.[/quote]

In comparison to Vietnam, Vietnam tries to keep its currency too expensive compared to dollars — a hard feat to do, as you are fighting against market forces.

China, in contrast wants to keep its currency cheap compared to the dollar. That’s easy to do — just print more money.

Dangerous, mind you. But easy.

On a related note, there is a thoery in economics called the Impossible Trinity that goes into this. Basically, you can’t have your cake and eat it too. A country has to pick two out of the three possible scenarios:

-Fixed Exchange Rates
-Independent Monetary Policy
-Free Captial Flows

China has chosen to fix their exchange rate and maintain independent monetary policy but has given up free capital flows.

[quote]and1bball4mk wrote:
On a related note, there is a thoery in economics called the Impossible Trinity that goes into this. Basically, you can’t have your cake and eat it too. A country has to pick two out of the three possible scenarios:

-Fixed Exchange Rates
-Independent Monetary Policy
-Free Captial Flows

China has chosen to fix their exchange rate and maintain independent monetary policy but has given up free capital flows.
[/quote]

Never thought of it that way, but I can see your point, and agree. The US does the bottom 2.