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US impact of China’s devalued currency

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Chi­nese offi­cials last week announced the deval­u­a­tion of the country’s cur­rency, the yuan, in a sur­prise move that some con­tend is tied to the nation’s slowing economy.

Last week, the yuan was down 4.4 per­cent against the U.S. dollar, which could have sig­nif­i­cant impacts on U.S. exports to China, as well as the global economy as a whole.

Tra­di­tion­ally, the yuan’s value is directly linked to the dollar’s value. But this move, according to reports, ties the currency’s value more to the market—the more common prac­tice for set­ting cur­ren­cies’ values.

Here, Kamran Dad­khah, an asso­ciate pro­fessor of eco­nomics at North­eastern Uni­ver­sity with exper­tise in inter­na­tional eco­nomics, describes the deval­u­a­tion process and what it could mean for the U.S. economy.

A cur­rency devalued

In very simple terms, let’s say that 6.4 yuan buys a U.S. dollar,” Dad­khah explained. “If you devalue the yuan, you have to pay more, say 6.5, yuan to get a dollar.”

As a result, the imme­diate price of Chi­nese goods and ser­vices will be less for the out­side world, while imported goods will become more expen­sive for Chi­nese cit­i­zens. The depre­ci­a­tion, Dad­khah said, is intended to boost exports and impede imports to improve the country’s bal­ance of trade.

A free exchange rate

The Chi­nese gov­ern­ment would like to see the yuan become more of an inter­na­tional reserve cur­rency, according to Dad­khah, but this won’t happen with its tra­di­tional way of set­ting a value based on the U.S. dollar.

They want their cur­rency to become an inter­na­tional reserve cur­rency, but that requires a free exchange rate,” he noted. The cur­rent depre­ci­a­tion, although small and enacted in response to short term prob­lems, can be con­sid­ered a first step in freeing the exchange rate.

Basic reform leads to improved results

Dad­khah explained that prob­lems in an economy are not unusual. “It should not be treated like the roof is coming down,” he said. “Indeed, eco­nomic growth and eco­nomic fluc­tu­a­tions stem from the same ele­ments and activities.”

The issue tends to lie in how offi­cials ini­tiate such reforms. “The problem is when the economy is doing fine, it is dif­fi­cult to imple­ment reforms, because people believe when some­thing isn’t broken it doesn’t need to be fixed,” said Dad­khah. “But to carry out reforms when the economy isn’t doing well will add to the suf­fering and may be opposed by those affected.”

One reform Dad­khah said China will have to con­sider is relying less on exports while encour­aging domestic con­sump­tion. The country, he added, should also encourage inno­va­tion, which seems to be the goal of the government’s planning

The impact on the U.S. economy

The rela­tion­ship between the U.S. and China is partly based on their deal­ings in the import-​​export busi­ness, but, Dad­khah said, their finan­cial ties do not end there.

In 2014, the U.S. imported $525 bil­lion worth of goods and ser­vices from China and exported $181 bil­lion. China also holds more than $1 trillion—or about seven percent—of the U.S. gov­ern­ment bonds.

A slow­down in the growth of a trading partner and a deval­u­a­tion of its cur­rency will have reper­cus­sions in the U.S. economy and the stock market,” Dad­khah said. “But the reper­cus­sions in Asian economies will be stronger.”

-By Joe O’Connell

Published On: August 18, 2015 | Tags: ,,,
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