Floating exchange effect on China
About this video
Sal imagines China letting the yuan float freely against the dollar. A stronger yuan would make Chinese exports more expensive and slow the economy somewhat, but it would also slow inflation and make imports like oil cheaper. He argues manufacturing would probably not return to the US or Europe, but China would face competition from other developing regions.
You'll be able to
- explain why a stronger yuan would reduce demand for Chinese exports.
- explain two ways a stronger yuan would help reduce inflation in China.
- evaluate whether manufacturing would leave China if its currency strengthened.
Key words
- Floating currency
- A currency whose value is set by markets rather than held at a level by the government.
- Peg
- A government policy of keeping its currency at or near a fixed value against another currency.
- Exports
- Goods a country makes and sells to other countries.
- Imports
- Goods a country buys from other countries.
- Inflationary spiral
- A situation where rising prices feed further price rises, getting harder to control.
- Commodities
- Basic raw materials, like oil, that are traded globally.
Transcript
Lets think about what would happen inside of China. If the government would allow its currency to completely float against the dollar, so, we know that the by-product would be its currency would strengthen. So far, they are artificially weakening it. So, you would have a [stronger yuan] and you would have a [weaker dollar]. I want to be clear that the Chinese government actually has been allowing yuan to slowly strengthen against the dollar, but it'€™s keeping maintaining a peg. We want to just think about what would happen if it's completely float.
Now, the obvious by-product of this that we know kept the currency weak that favors its exports. It would allow the exports to be cheaper, creating demand for the exports. Now, they allowed their currency to strengthen. Then their exports would be more expensive than the other countries. So, it would [decrease demand for exports].
Now, with fewer exports, fewer production perhaps in their factories now. This, obviously, would [slow down the Chinese economy]. Now, this we have to be careful here. When we say slowdown, just that doesn't mean that they necessarily fall into a recession. They have been growing at high single digits to low double digits for many many many years now.
When we talk about slowing down, they might slow down to may be 4 to 5% growth, which is still super fast by any other nation's standards. We have also seen that there is ton of inflation in China. And, to some degree, it kind of hints that the Chinese consumer is ready to take up the slack from foreign consumers.
So, may not even slow down as we might first think. That brings up the first unambiguous positive behind allowing the currency to strengthen. If they would actually stop printing the Yuan, and start buying other currencies. It would actually [slow down inflation]. And, we know that we are dangerously close to kind of inflationary spiral.
They have been reporting 5 to 6% of inflation. The reality might be closer to 10%. And, the inflation is actually going to be mitigated not just from the fact that you have lesser yuan running around, and the economy is slowing down. But, it is also because Yuan is strengthening. When it is stronger, it allows them to buy imports more cheaply.
For the Chinese, perhaps the most important import is import of commodities. And, most important of the commodities is Oil. So, the price of Oil would go down. Now, the bigger question that is harder to answer is what happens to Chinese manufacturing in general?
Lot of the people the argument why China is able to build its manufacturing basis is that they have this weak currency. That has allowed them to build ecosystems, get to scale in its factories. Will the manufacturing then go back to US or Europe? My gut is that it would not go back to US or Europe. Because, any thing that requires huge amount of scale and huge amount of labor is going to be very hard for the Chinese - to compete with Chinese, even if the currency was stronger. I think at that point of time, China has to worry about other developing nations may be India, may be Latin America. While they have labor advantages relative to China and if they were able to have same kind of efficiencies in the infrastructure and in the same scale
then they would be able to give them a run for their money. This is Salman Khan of KhanAcademy for CNBC.
Video © Khan Academy, used under CC BY-NC-SA. Watch on Khan Academy. Puzzicle is not affiliated with Khan Academy.