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How China is fixing its exchange rates:Another, less used means of maintaining a fixed exchange rate is by simply

making it illegal to trade currency at any other rate. This is difficult to enforce and often leads to a black market in foreign currency. Nonetheless, some countries are highly successful at using this method due to government monopolies over all money conversion. This was the method employed by the Chinese government to maintain a currency peg or tightly banded float against the US dollar. Throughout the 1990s, China was highly successful at maintaining a currency peg using a government monopoly over all currency conversion between the yuan and other currencies. WHY PEOPLE OPPOSE FIXED EXCHANGE RATES:1.The main criticism of a fixed exchange rate is that flexible exchange rates serve to automatically [5] adjust the balance of trade. When a trade deficit occurs, there will be increased demand for the foreign (rather than domestic) currency which will push up the price of the foreign currency in terms of the domestic currency. That in turn makes the price of foreign goods less attractive to the domestic market and thus pushes down the trade deficit. Under fixed exchange rates, this automatic rebalancing does not occur. 2. Moreover a government, when having a fixed rather than dynamic exchange rate, cannot use monetary or fiscal policies with a free hand. For instance, by using reflationary tools to set the economy rolling (by decreasing taxes and injecting more money in the market), the government risks running into a trade deficit. This might occur as the purchasing power of a common household increases along with inflation, thus making imports relatively cheaper. Additionally, the stubbornness of a government in defending a fixed exchange rate when in a trade deficit will force it to use deflationary measures (increased taxation and reduced availability of money) which can lead to unemployment. Finally, other countries with a fixed exchange rate can also retaliate in response to a certain country using the currency of theirs in defending their exchange rate The belief that the fixed exchange rate regime brings with it stability is only partly true, since speculative attacks tend to target currencies with fixed exchange rate regimes, and in fact, the stability of the economic system is maintained mainly through capital control. A fixed exchange rate regime should be viewed as a tool in capital control. For instance, China has allowed free exchange for current account transactions since December 1, 1996. Of more than 40 categories of capital account, about 20 of them are convertible. These convertible accounts are mainly related to foreign direct investment. Because of capital control, even the renminbi is not under the managed floating exchange rate regime, but free to float, and so it is somewhat unnecessary for foreigners to purchase renminbi.


.. Another long term threat to China's continued economic growth is the deterioration in the environment. Also. some familiar old arguments are being trotted out to fend off pressure and delay currency appreciation by Chinese officials and some analysts working on China. dollar. China was persuaded to keep its exchange rate fixed against the U.and an increasingly de-centralized economic system is also a cause of tension. China continued to defend a pegged exchange rate until July 2005 (when the rate was revalued slightly and allowed to appreciate gradually until August 2008. just as it had been in 1997-98. At that time. There is truth to this claim from a narrow statistical point of view. then that would. China has undertaken a major highway construction program and China is working hard on building world-class infrastructure.The first old argument making a comeback is that a stable yuan is not only good for China. of course. dollar when its currency was facing downward pressure to prevent setting off a round of competitive devaluations among the crisis-stricken countries in the region. The roots of this argument go back to the Asian financial crisis of 199798. Nevertheless. These faulty arguments should be ignored. dollar) as being in the best interest of China and the rest of the world. China faced the challenge of balancing its highly centralized political system with an increasingly decentralized economic system. at which time the rate was effectively repegged to the U. As the second or third largest economy in the world. continues to suffer from inadequate transportation. Other critical problems include corruption.S. China's poor human development index highlights the economic disparity between urban China and the rural hinterlands. soil erosion and the steady fall of its water table in the nor Arguments provided by china to not devalue its currency:Flawed Arguments for a Stable Yuan With pressure growing on China to allow the yuan to appreciate. Tensions between a highly centralized political . China's actions in 1997-98 are being invoked by officials in Beijing as justification for China's decision during the current economic and financial crisis to maintain a stable exchange rate against the U.. notably air pollution. any competitive disadvantage that China may have suffered was quickly more than offset in the period after the crisis by the rapid growth in productivity in China relative to its competitors.S. despite a burgeoning trade surplus. The authorities in [developed] countries are coming to see China's exchange rate policy as an important distortion in the world economy that will hold back adjustment of global imbalances and slow the recovery of other economies worldwide.S. and the growing rate of HIV infection. raise the average rate of growth for the world economy.. However. though strengthened by liberal economic policies of the 1980s and 90s. and the heat should remain on China for a needed change in exchange rate policy. That impact depends on how much growth in China's demand is . communication. which affects every level of society. and energy resources. But that does not mean China's growth is adding measurably to the growth of other countries. but is good for the rest of the world.In the early 21st century. Human rights campaigners continue to criticize China for executing hundreds of people every year and for failing to stop torture. !. since the 1980s. It is argued that this policy helped to support China's growth during the recession and that it is good for the rest of the world because strong growth in China's economy makes a major contribution to recovery in the world economy. China's economy. if China grows faster.. While at the time this was a very important policy decision by the Chinese authorities.

It’s main imports are electrical components and other machinery. Japan (8.1%) China Imports In 2010.3%). Such a boost to these countries' economies is characterized as being small and not critical to addressing global imbalances. oil and mineral fuels.131 trillion in 2008.9%).2%) and Germany (4. it continues to subtract significantly from net world demand. The reality is that China with a large trade surplus sells substantially more to the rest of the world than it purchases. apparel. China would continue to be the world's leading exporter because it has a major competitive advantage in manufacturing. South Korea (9. In 2010. Therefore.7%). textiles. and it will diminish in 2010 and the years beyond as China's trade surplus is expected to start rising again. plastics and organic chemicals. changing China's exchange rate cannot be expected to make a major contribution to boosting the net exports of developed countries. the rest of the world as a whole is not benefitting much from China's strong growth. Manufacturing in the developed countries would not recover. an extra half percentage point boost to growth that would come from China permitting its exchange rate . Hong Kong (13. when the developed countries are looking at prospects for annual growth of 1-2 percent. US (7.5 billion. and the decline in China's trade surplus in 2009 means it took less away from net world demand than in previous years. optical and medical equipment.194 trillion. metal ores. some analysts argue that even if China's currency were allowed to appreciate such that China's current account surplus would decline by 4 percent of its GDP annually and return to a level more in line with the country's long-term fundamental saving and investment balance. China's contribution to the rest of the world's growth has not been much. Thus. down from $1. down from $1.2%) and Germany (4. It’s main exports are electrical goods and other machinery. the argument concludes. Even with a higher value for the yuan. Some countries (particularly those in Asia and commodity producers) may be benefitting. and therefore. China's main export partners are US (17. South Korea (5.9%). China's Competitive Advantage Another old argument still making the rounds is that even if the yuan were allowed to appreciate significantly. However. China imports totaled $921. including data processing equipment.contributing to stimulating growth in other countries. Nevertheless. For instance. this would directly contribute only about a half percentage point to annual growth in the developed countries. China exports totaled $1.3%).429 trillion in 2008. optical and medical equipment. it would not materially change the pattern of imbalances among the world's major economies because it is not the root of the problem. China's main import partners are Japan (13.1%). iron and steel.

A program is deemed specific if it is granted selectively. it must be "specific. it must confer a "benefit" on its recipient.In our view. And the heat needs to stay on.the clearest case would be a sum of money granted by a government to an industry. it must entail a governmental "financial contribution. however. as indicated by President Barack Obama's concerns about the value of the yuan expressed in recent remarks. the old argument is clearly wrong. In these circumstances. This is said to be particularly true at the moment because relations between China and some of the developed countries. because the trade-distorting potential of a "financial contribution" can be identified by determining whether the recipient has received a "financial contribution" on terms more favourable than those available to the recipient in the market. China's leaders do not want to be seen as bowing in the face of foreign pressure." According to WTO texts. there is the grand old argument that the Chinese authorities do not respond well to external pressure for policy change. one may look at the Illustrative [4] List of prohibited export subsidies annexed to the SCM #3 benefit:. it is possible that the provision or the conversion of foreign currency at a fixed rate could be perceived as equivalent to a service given by the Chinese government or by bodies entrusted by it. the United States would have to demonstrate that these criteria are simultaneously satisfied. A change in China's exchange rate policy is a critical element in the world economy's recovery. the boost to developed country growth would permanently raise the level of incomes and employment in the developed countries. in law or in fact. The Need to Press Beijing Finally. especially the United adjust is no small matter. First. Since this system would most likely be challenged as a de facto export subsidy.":. In other words. Chinese authorities recognize that China needs to change its growth model and rebalance its economy away from heavy reliance on investment and exports to generate growth toward greater reliance on consumption. and a change in China's exchange rate will come at a more appropriate time. In addition. The reality is. And when patience grows thin and pressure rises again. In order successfully to challenge the Chinese fixed exchange rate system as a subsidy. In a world economy looking for new sources of stimulus to spur demand growth (and developed countries as a rule having little scope to make further use of fiscal policy). It is understandable that a country might resist being called on to make a policy change that would entail a sacrifice to benefit of the rest of the world. Changing exchange rate policy in China is a political decision made at the highest level of government. That will not be accomplished unless greater flexibility and an appreciation of the exchange rate are permitted. China's contribution to rest of the world's growth has not been much. in . other countries will feel justified in strongly pressing China to change its exchange rate policy." and third. But that is not the case in this instance. China has to act soon and in a decisive manner to avoid doing itself great harm WHY WTO IS not Doing ANYTHING The question is whether a WTO panel would regard the Chinese fixed exchange rate system as a "subsidy. #1 Specific:. this half percentage point addition to growth from foreign demand would further stimulate economic activity in the developed countries so that. There are no good reasons for other countries to diminish their pressure on China to change its exchange rate policy. a practice is an "actionable" subsidy (a subsidy that can be challenged) if it satisfies three criteria. The heat is on. and it will diminish in 2010 and the years beyond as China's trade surplus is expected to start rising again. #2 Regard to the governmental "financial contribution. it is not specific and therefore not an actionable subsidy. the impact of such a change in China's exchange rate policy would be even greater. other countries will ramp up pressure and are likely to choose to retaliate against China's exports to try to force a change. At first glance. have become increasingly tense. Accordingly. that without pressure being exerted to encourage a change in its exchange rate policy. it does not seem that the Chinese "undervalued" fixed exchange rate system could fit in one of these categories." Second. Also. However. In fact. China will have no reason to move. if it is available for all the sectors of the economy. the marketplace provides an appropriate basis for comparison in determining whether a "benefit" has been "conferred". to an enterprise or group of enterprises. The suggestion from this argument is that the rest of the world should ease pressure on China. ultimately. Increasingly. If China continues to resist. the Chinese authorities could choose to cling to the current fixed exchange rate policy to project strength. this same argument will be trucked out once more to try to further postpone policy adjustment.

the case of the Chinese fixed exchange rate system. Of course. it seems that the free marketplace is not only difficult to identify. since without this demonstration there is no question of finding a benefit. There is no currency exchange market in China or elsewhere for the Yuan where its value is determined by the interaction of the forces of supply and demand. . a convincing economic demonstration that the Yuan is currently grossly undervalued would be necessary. but is simply non existent.