The US-China Exchange Rate Stand-Off

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Case Details:

Case Code : ECON019
Case Length : 18 Pages
Period : 2002-2007
Pub Date : 2007
Teaching Note :Not Available
Organization : -
Industry : -
Countries : China and USA

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Introduction Contd...

Criticism of China's currency policy grew after China's accession into the WTO, which allowed China's share of world exports to grow from 4.4% in 2001 to more than 8% (2006), with a significant portion of these exports reaching US shores. Post-WTO, the US government had been using several means - including the threat of trade sanctions - to pressurize China to revalue its currency against the US Dollar. The Chinese government, on the other hand, maintained that the exchange rate of the Yuan against the US Dollar was not fixed. However, some Chinese officials agreed that their government did intervene to maintain the exchange rate within a narrow band. But they added that a stable Yuan-Dollar exchange rate was necessary as it promoted economic and financial stability in China.

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 While US government and trade representatives were critical of China's alleged pegging of the currency, economists were of the view that undervaluation of the Yuan against the Dollar brought some benefits to the US economy as well. The low prices of imported Chinese goods lowered the costs for US firms that used these cheap Chinese imports as inputs in their production. Also, the cheap Chinese imports helped keep inflation down in the US. 

Background Note

The international monetary system, as we know it, has been in existence since the 19th century. Prior to 1870, countries adopted different monetary systems such as bimetallism, gold, silver, and inconvertible fiat currencies. After 1870,11 many countries adopted gold convertibility.12 Gold was chosen because of its international recognition and its characteristics such as divisibility into standardized units (ounces) and storability. Most importantly, gold was thought to contribute to economic stability. Under the gold standard, each currency was defined in terms of its gold value. The US Dollar, which was unconvertible earlier, became gold convertible in 1879...

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11] This happened after delegates (from 20 European countries and the USA) to the International Monetary Conference, held at Paris in 1867, decided to adopt a monometallic uniform monetary system.

12]  The free convertibility of a currency exclusively into gold.

13]  1 troy ounce was equal to 480 grains of pure gold.


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