China in 2005: The Yuan Revaluation and Beyond

Abstract

In July 2005, China announces it is revaluing the Yuan. The long awaited move has major implications for the global economy. Economists wonder what the long-term impact of the Yuan revaluation will be. Will the revaluation help in correcting some of the imbalances in the global economy? Or will it lead to a global slowdown?

INTRODUCTION

In July 2005, China announced it was revaluing the Yuan. The long awaited move had major implications for the global economy. Economists wondered what the long-term impact of the Yuan revaluation would be. Would the revaluation help in correcting some of the imbalances in the global economy? Or would it lead to a global slowdown?

CHINA & THE GLOBAL ECONOMY

By holding down bond yields, China had fuelled excessive household borrowing and spending in the US.'The Economist' had pointed out that global monetary policy seemed to be made in Beijing and not in Washington. China's profound and widespread impact on the world economy was evident in various anomalies, which had been visible in recent times.

Since the beginning of 2004, oil prices had doubled. But unlike previous oil shocks, global inflation rates had remained low and growth robust. The reason seemed to be China. Oil prices had been driven up by strong Chinese demand rather than, due to interruption of supply as in the past. At the same time, the impact of higher oil prices on inflation had been offset by the falling prices of various Chinese goods. Competition from China and the threat that firms in developed countries might shift offshore had also helped to keep wages low and hence inflation.

China's ability to produce more cheaply had pushed down the prices of many goods worldwide, as well as restrain the wage pressures in developed economies. For instance, over the past ten years, the average prices of shoes and clothing in America had fallen by 10% or a drop of 35% in real terms.

As China had helped in reducing inflationary pressures, central banks were able to hold interest rates lower than they otherwise would have. Three and a half years into its recovery America's real short-term interest rates were only 0.7%, almost two percentage-points below their average at the equivalent stage in previous recoveries since 1960.The soaring house prices in many countries at a time of low inflation also seemed to be because of China.

Cheaper goods from China had made it easier for central banks to control inflation without having to raise interest rates sharply. Low real interest rates had encouraged heavy borrowing, which had flowed into the prices of assets, such as homes. American bond yields were low despite robust growth and hefty government borrowing, because China had bought large quantities of US Treasury bonds to hold down the Yuan. The People's Bank of China (PRC), China's central bank had also supported America's mortgage market by buying vast amounts of mortgage-backed securities.

More>>

        Case Code   ECOA137
   Case Length    13 Pages
              Period    -
 Organization     -
        Pub Date     2005
Teaching Note    Not Available
     Countries    China & World Economy
      Industry    -

Issues                 -

China, World Economy, Yuan Revaluation, Global implications of revalued Yuan, Geopolitical implications and Long-term implications.
 

Please note:

This case study was compiled from published sources, and is intended to be used as a basis for class discussion. It is not intended to illustrate either effective or ineffective handling of a management situation. Nor is it a primary information source.