Impact of the Renminbi peg to the US Dollar on the Chinese and global financial markets

Abstract

The Chinese central bank has had a history of following a fixed currency regime. They do this by pegging the Yuan/Renminbi to the US Dollar. The peg has prevented the appreciation of the Yuan against the Dollar which has helped allegedly helped China boost its exports. The peg has aided the manufacture of cheaper goods in China, which has been touted as one of the factors that have driven the growing consumerism of the United States over the past couple of decades. This trade imbalance, where China had imported less than they had exported to the United States has allowed China to accumulate a large amount of US Dollars. Thus the peg is also important as it prevents the appreciation of the Yuan which would devalue these holdings. However in the aftermath of the financial crisis, there has been a change in the economic scenario in most countries. Legislators in the Unites States blame the ?manipulation? of the Renminbi for the increasing trade deficit and rising joblessness in the United States. The peg is also blamed for the reason most other Asian currencies cannot allow their currencies to rise against the dollar, as this appreciation will damage their competitiveness relative to China. Thus there has been increasing pressure from the United States, the IMF and the finance ministers of the G-7 nations to revalue its currency. On June 19th, amidst pressure from the global leaders and possibly as a sign of its desire to join the G-7, China announced that it will abandon its currency peg with the US dollar and will manage it against a more flexible basket of currencies. This project studies the impact the peg between the Yuan and the US Dollar had on the economy and the financial markets. The first section of this report looks at the history of the peg between the two currencies. The second section looks at the similarities between the Chinese economy today and the Japanese economy in the 80‘s which had a similar peg and was equally bullish on export. The next two sections look at the benefits and the problems that the global economy and the Chinese economy faced due the peg between the dollar and the Yuan. In light of these two sections, the fifth section looks at the reasons why the Chinese need to revalue their currency. Section 6 looks at the benefits that the revaluation offers to the Chinese economy and Section 7 looks at the impact of the revaluation on the global economy. We conclude the study by looking at the impact of this revaluation on the Bond, Foreign Exchange and Commodity financial markets.