Bowing to pressure from home and abroad, China’s currency has climbed to new highs against the US dollar since the central bank’s pledge to allow the yuan to appreciate further in June 2010.
One source of pressure to appreciate has come from countries other than the US who have seen the yuan – which is still partly pegged to the dollar – fall as the dollar has decreased. This has made Chinese products more competitive than theirs.
What’s more, given China’s great trade surplus with the US, the US has also put much pressure on China to push up the yuan’s value.
The second source of pressure is inflationary, as the People’s Bank of China has used yuan appreciation to ease the country’s imported inflation.
As a major importer of raw materials, purchasing 10 percent of the world’s crude oil, 65 percent of its iron ore, 30 percent of its copper and 53 percent of its soybean output, China is sensitive to commodity price fluctuations in global commodities.
In the first quarter of this year, most commodity prices surged. The crude oil price grew by 59.5 percent quarter-on-quarter; soybean by 25.7 percent; and copper by 6.6 percent.
Allowing the yuan to appreciate is a means of offsetting the higher price of global commodities, and thereby checking inflation.
However, the rapid yuan appreciation has impacted on China’s exports, shrinking the value of the country’s foreign exchange reserves, while also encouraging commodity speculation.
China’s export trade rose in May by 19.4 percent month-on-month, far more slowly than the 29.9 percent seen in April, hurting economic growth. The slowdown was mainly attributable to rapid yuan appreciation. The average profit margin of export companies in the first two months of this year was down to 1.44 percent, far lower than the figure for China’s industrial enterprises as a whole.
Although domestic export-oriented companies are taking action to adapt to the appreciation of the yuan, the appreciation has been so rapid that many have not had enough time.
China’s foreign exchange reserves – over $3 trillion, largely dollar-denominated – have been shrunk by the yuan’s appreciation. The rapidity of appreciation has been such that the country has had little time to react by diversifying its forex holdings.
In addition, the rapid increase in the yuan encourages overseas speculators to buy up commodities that they believe China will be in need of, in the hopes that the profit they make will be boosted by the subsequent rise in the yuan. This kind of activity itself inflates the price that China must pay for its commodities, while encouraging the yuan to appreciate even further.
As such, China should slow down the rate at which it allows the yuan to appreciate. This would give domestic exporters more time to adapt, while also discouraging speculative trading that could harm the country by pushing up prices and inflation.
The author is an economist at Renmin University of China. firstname.lastname@example.org