In recent years China has been artificially keeping its currency, the Yuan, low to boost exports and ensure jobs for the low wage earners in the country. This strategy has kept China's economy growing at the fastest of all of the world's large economies. However, this growth has happened at the cost of the U.S. and others who cannot compete with China's artificially low prices. The U.S. has been experiencing an unprecedented current account deficit with an imbalance of $617.6 billion in 2005, $162 billion of that due to China.
Pressure to adjust exchange rate
Because of the huge trade deficit, the U.S. has pressured China to allow its currency to appreciate. The current administration has vocalized its concern about the currency valuation and will likely demand more from China in the future. Congress has even proposed a special tariff that will be imposed on Chinese goods if China does not relax its currency policies.
Adjusting to get back to normal
Despite pressure from the U.S. China has done little to loosen their exchange rate. In June of 2005 China increased the value of the Yuan 2.1%. This was the first adjustment since the fixed exchange rate policy was introduced in 1995. Today the Yuan is considered to be undervalued by as much as 40%. To get the Yuan to a price that is close to its actual market value China would have to move slowly so its export industry could absorb the revaluation over time and slowly adjust. A large adjustment in the Yuan could be very traumatic to the economy.
Coming changes in the Yuan rate
China is likely to take serious steps to adjust its currency in the coming years. As the country becomes developed the fear of inflation and foreign competition will fade. In doing so, the reasons for having a fixed currency will disappear and the Yuan will be weaned of the current strategy and allowed to be traded freely.
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