Appreciating the Yuan: Effects on China and Korea

One country’s currency is being hotly discussed as the topic of worldwide discussion: the Chinese currency, RMB (yuan). Endless criticism of its undervaluation has swept the media – various economic and political figures of the U.S such as President Obama, Ben S. Bernanke, and Paul Krugman has all noted that the Chinese currency must be appreciated to match its actual value. American manufacturers protests that yuan is currently undervalued up to 25-50% of its original value and thus should be appreciated. So what are the grounds of such statements and what are the expected effects?

The Undervalued Yuan Problem

The Undervalued Yuan ProblemThe foremost reason is global imbalance of trade surpluses. The fixation of the Chinese currency to the dollar since 2008 has brought China an enormous amount of trade surpluses – recording surpluses up to $30 billion a month in its current account.  Now its total foreign currency reserves amount to 2.4 trillion US dollars, which is 50% of its GDP. This was deemed to have been possible by exporting cheaply, which in consequence has been affecting current account of other countries by relatively lowering their competitiveness in export. The U.S is not the only one claiming disadvantage in trade – recently India and Brazil have also voiced their discontent regarding such currency measures of China.

The high unemployment rate in the U.S is also attributed to the undervaluation of yuan. The lowering of export competitiveness does not only affect current account but is also related to domestic economy. As exports lose its competitiveness, the related industries naturally have been losing the incentive to hire.

Despite the above arguments that blame the yuan, some others mention that problems cannot be completely attributed to its undervaluation. Joseph Stiglitz recently mentions that the trade deficits of U.S will not be cured after the appreciation of yuan because world trade will naturally favor other developing countries which offer cheap export goods compared to those of the U.S. In addition, the Center for Economic and Political Research (CEPR) also mentions that the appreciation of yuan will actually result in increase of unemployment – as imports from China by the U.S not only include imports of finished goods but also middle goods which contribute to the production of export goods made in the U.S. Such will then adversely affect employment than expected. Another retort to note is the expected effect in the U.S financial market. The appreciation of yuan will make the U.S bonds less attractive, leading to fewer sales to Chinese buyers, who are usually the largest consumers of the U.S government bonds.

Effects on China and Korea

Despite such various views, it seems that China will appreciate the yuan in the near future. The governor of People’s Bank of China mentioned last month that its fixed exchange rate system was a distinct response to the financial crisis, and thus it should be rearranged shortly. Also, experts view China will use the currency to control overheating of its economy. Hidden behind its high current account surpluses lies rapid increase in real estate prices – it has increased by 75% compared to that of last year. The appreciation of the yuan can help alleviate real estate bubble.

Another reason why China might soon appreciate the yuan is to control inflation. The price level has increased by 2.7% compared to last year’s quarter, which is nearly reaching the maximum price level increase rate of 3% set by Premier Wen Jiaobao.

One positive effect that the appreciation of the yuan will have on the Chinese economy is the reinforcement of domestic market targeted industries as appreciation will increase the purchasing power of Chinese people. The domestic demand oriented industries are already experiencing positive response – their stock prices were raised 1~5% due to the recent news regarding the expected appreciation of the yuan. The actual appreciation may lead to much more increase in stock prices later in the future.

On the other hand, Korea will be affected both positively and negatively. Regarding trade, it is likely that Korean exports may gain price competitiveness, in products such as home electronic products. However at the same time, as China reduce its exports to the world, exports from Korea to China may fall, leading to gradual decrease in Korean export trade surpluses.

Another problem is the rise in the Korean currency won with the rise of yuan. Such decoupling effect is evident, where dollar is weak in Asian markets compared to advanced markets. The value of won to dollar has been rising – on April 27th, the exchange rate of the won against the UD dollar dropped to as low as 1,104 won – the lowest in 19 months. The tendency is likely to continue when remembering the movement of the rate in 2005 – with the appreciation of the yuan by 2%, the value of the Korean won against the US dollar rose by 1.4%. Such rise in the Korean won can ultimately lead to decrease in competitiveness of export goods.

Facing both positive and negative effects, experts note that Korea needs to find ways to increase competitiveness of export goods amidst rising value of won.

Eunhou Song (amber1547@gmail.com)

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