U.S. Foreign Exchange and the Chinese Currency Exchange Rate

U.S. Foreign Exchange

The number of international corporations and financial professionals that follow the ever-changing ratio of U.S. dollars to Chinese Yuan has increased and expanded beyond its borders. This is an indication of just how critical the trade relationship that binds the world’s two largest economies has become. Although the relationship between the United States, Canada and Mexico continues to be even more robust than the Sino-American arrangement, the consumer economy of the United States is heavily dependent upon smooth flows of goods from the workshops of China to the Pacific ports of California and Washington State. In many ways, the continued harmonious economic relationship is as important to the United States as modern technological innovations in the financial field (such as the latest trading and communications technologies, see OANDA for more information).

U.S. Foreign Exchange, the Yuan and the Flow of Goods

The value of the yuan has a tremendous influence on these flows of goods. Most of the export-ready products that Chinese factories produce for American consumption are low-margin consumer goods that require labor and raw materials to produce. Since these goods must be shipped thousands of miles across the ocean, global fuel prices add a significant and non-negotiable premium onto their final cost. As such, Chinese manufacturers have a keen interest in ensuring that the value of the yuan remains low enough to offset the added expense of bringing their products to market in the United States.

China’s Devaluation of the Yuan

The Chinese yuan used to be pegged the US Dollar to facilitate trade, this ended in 2005. Business deals were still denominated in dollars but after 2009 the government allowed transactions to be settled in yuan, instead of the traditional US dollar. The Yuan went from a peg to the US Dollar, to being pegged to a basket of currencies with unknown weights assigned this resulted in a systematic devaluation of the yuan relative to the dollar. According to closely-watched metrics of purchasing power parity, the yuan has been artificially devalued by as much as 37.5 percent in the past. However, its value has lately risen slowly but steadily as the result of several interconnected factors. Current estimates indicate that it is now about 8 percent weaker than it should be.

Yuan Under Pressure

First, the yuan has appreciated thanks in part to American economic stimulus measures. As the U.S. economy continued to stagnate in 2009 and 2010, the Federal Reserve embarked on an aggressive program of bond-buying known as quantitative easing. This caused a chain reaction in which interest rates on U.S. Treasury bonds remained artificially low and the value of the dollar followed suit. On the other hand, prices for U.S.-traded stocks rose sharply. This caused the dollar to weaken relative to the yuan.

The “passive” pressure of quantitative easing has been coupled with overt trade pressure from American authorities. In order to protect American manufacturing jobs during and after the recent recession, the U.S. government has applied political pressure to China’s currency regulators. The gist of the argument is simple: The yuan has remained far too weak for far too long. The governments of some other developed economies sympathize with the American position. Although the imposition of debilitating tariffs has been limited to a few niche industries, the Americans have successfully used the constant threat of such artificial trade barriers to encourage the Chinese to soften their support for a weak yuan.

Rise of the Chinese Middle Class

Finally, an encouraging secular trend has also contributed to the progressively-stronger Chinese currency. In the past few years, a greater proportion of the goods manufactured in China have remained within the country’s borders thanks to a growing cadre of relatively affluent and urbanized Chinese consumers. This new Chinese “middle class” has spurred an increase in domestic factory production while simultaneously reducing the need for an export-friendly currency policy. As this trend continues, the value of the yuan may continue to rise relative to that of the dollar.

In the long run, the rising value of the yuan is likely to reduce the trade imbalance between China and the United States and make American goods more competitive on the Southeast Asian market. However, China’s economic development remains at least somewhat subject to the whims of its central planning authorities. An abrupt and unexpected shift back towards a weak yuan could well disrupt this long-term re-balancing act.

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Alfonso has been covering the Forex market for more than 10 years, working at trading desks and global research and analysis teams. He works regularly as a market specialist in business dailies and online portals. You can read more of Alfonso’s work at Google+.

Image courtesy of Stuart Miles / FreeDigitalPhotos.net