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July 9, 2010

How the Change in the Chinese Currency Affects Us

Last month, the Chinese announced that they will stop controlling the value of their currency, the Yuan, and make it more flexible to be valued by the trades of the international markets.  This was after years of pressure from the United States and lately, from the Obama Administration to do so.  Now, the recent move by the Chinese does not make their currency as openly traded as that of the dollar, but it moves the Yuan closer to doing that.
By loosening its control over its currency, China is allowing Yuan to become more expensive, compared to other countries’ currencies.  Why would the Chinese want their currency to be cheap?  As an exporter, the lower in value your currency is, the cheaper your goods are.  The cheaper a country’s goods are, the more they sell, and therefore the more money is made.
Over the past 25 years, the Chinese have created a middle class based on this strategy.
So what does this mean for our country?
Imports will become more expensive.  Since we import most of our consumer products from China, import prices and overall consumer goods prices will increase.  This could also have an upward effect on inflation, since the CPI, the headline number used for inflation, is made up of consumer prices.  Union workers will rejoice as the products manufactured in America will become more desirable.  However, as we learned from the steel tariffs, this will also increase the prices on domestically produced consumer goods.
The dollar will become weaker.  In a broader sense, the Chinese will demand our currency less (as they buy U.S. dollars to keep their own currency weak) and with less demand the value of the U.S. dollar will fall.  If our currency is weaker, it will be more expensive for us to import from other countries (as opposed to importing from China only in the paragraph above).  The plus side of the weaker dollar is that our country’s exports will become less expensive to the rest of the world and therefore our exports will sell more.
Overall, the Chinese Yuan should be allowed to float like the dollar in order to equally compete in a global currency and trade market.  Despite this, the adjustments that are made to get there could equate to short term economic pain in the United States and other countries, including China.  It will be interesting to watch this currency situation unfold over the next several years.

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