The Sinking Yuan

What Currency Change Means for the U.S. and China

The Sinking Yuan
April 15, 2015

After rebounding slightly earlier this year, the value of the Chinese yuan against the U.S. dollar has fallen precipitously again over the past month. The recent fall of the yuan has been a major international economic story with serious potential implications for both the Chinese and U.S. economies, as well as investors.

How the Yuan’s Value is Controlled

The Peoples Bank of China (PBoC) controls the value of the yuan by setting a daily trading band: It can move up or down by two percent on a daily basis from a midpoint set by the PBoC.

Between 2008 and 2010, the exchange rate between the yuan and the dollar held steady at about 6.8 yuan to one dollar. However, it then began a slow but steady descent to nearly 6.0 yuan to one dollar in early 2014. The yuan rebounded to 6.27 yuan to one dollar in early March of this year, but it has since plunged again, falling to 6.21 on March 26.

2014 was the first year the yuan depreciated against the dollar since 2005, which marks a “significant turning point for the currency,” remarked the director of currency strategy for one U.S. investment firm in a recent Wall Street Journal article. He added that the falling yuan “is altering foreign investment opportunities in China.” Along with many other foreign exchange experts, this trader expects the yuan to fall further against the dollar this year. (It should be noted that most major currencies have fallen sharply against the US dollar over the past 12 months, so the falling yuan is hardly an anomaly.)

One factor in the falling yuan has been the slowdown in the previously red-hot Chinese economy, where growth fell to just 7.4 percent in 2014. While this sounds high in comparison to the rest of the world, it is significantly slower than the nearly double-digit growth China enjoyed for decades, and is barely enough to create jobs for the huge Chinese population.

Impacts of Sinking Yuan

A falling yuan is generally good news for the Chinese economy because it helps boost exports. And by raising the cost of imports, it may help stave off deflation in China. However, if the yuan continues to fall, this could spur an outflow of capital from China, which could be harmful to Chinese businesses.

From the U.S. perspective, it has been argued by many that China has deliberately kept the yuan weak to help Chinese exporters, thus giving them an unfair trade advantage against American businesses. If the U.S. and other leading world economies think that China is deliberately manipulating its currency to benefit Chinese exporters, this could lead to a full-fledged trade war.

The yuan-dollar exchange rate is one of the most influential foreign exchange rates in the world. Therefore, it bears close watching throughout the rest of this year and beyond. So does the dollar against other leading currencies, such as the Euro, Pound and Yen. Simply put, these are very interesting times in the currency markets.

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