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Valuation Of The Yuan

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In the news recently, there has been a great deal of talk about the subject of the valuation of the renminbi (yuan). What is all the fuss about and how does it impact the US and Chinese trade?

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Solution Summary

Discusses the causes and perceptions surrounding Chinese pegging of their currency to the US Dollar.

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The reasons behind the hotly debated valuation of the Chinese renminbi Yuan fiat currency has many facets however the predominant "story" covered by the 24-hour news cycle is that China is a "currency manipulator" or that the "value of the currency is too low" as it relates to trade balance.

http://www.bloomberg.com/news/2012-11-27/u-s-treasury-declines-to-name-china-currency-manipulator.html

So why would anyone care what China's currency value is relative to the U.S. dollar, and how does it impact the U.S? To understand this, one must observe Chinese government practices concerning interest rates. While it is much more in depth question to ask what factors drive currency exchange rate pairs, the long term answer is central bank interest rates or LIBOR to use a simple measure. The FOREX market is largest, global market in the world where currency is exchanged. Long term, the value of a currency tends to appreciate relative to another when it's interest rates are higher. Conversely, when interest rates are lower the value of the currency tends to decline. This is a direct result of the time value of money concept. More money, earning more interest = more money when converted back into a lower yielding currency. So let's say you peg interest rates relative to another currency, meaning you move your interest rates in tandem with that country, you essentially lock in "imbalance". This is exactly the practice China ...

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