China: To Float or Not To Float?

China’s exchange rate policy was described by many analysts as a manipulation of the exchange rate and that the Yuan was undervalued. This is why they (analysts in addition to American and European countries) are demanding more flexibility for the Yuan.

Actually, China’s exchange rate policy is disturbing USA and Europe trade balances and in the same time is attracting multinational companies. In fact, Analysts observe that between 2002 and mid-2005, when Dollar exchange rate against European currencies was falling, the exchange rate against Yuan remains fixed. China’s trade surplus reached record highs and US manufacturing jobs declined. We noticed that between 2001 and 2004, export of goods and services (in %GDP) increase from 25% to 40%. It becomes a sign of how this fixed exchange rate is implying an unfair competition between the two countries. Other economists are estimating that the argument that this advantage helped China to control economy and inflation became untrue. The globalization made these controls more difficult to enforce.

In the same time, this policy allows China to remain attractive to multinational companies and avoid falling foreign direct investment by avoiding deflation. It also avoids the risk that international firms move to other low cost region as India and Southeast Asia. It provides stability for its economy in transition, an importance condition for the prosperity of foreign companies. We noticed that between 2002 and 2004 foreign invested move from 169.9 to 338.6 (billions U.S dollars).

Although, it seems that People’s Bank of China adopted a new strategy. It introduced a new exchange rate mechanism in which market forces will play a more important role. It’s maybe a new way to a float currency. Some impacts of this measure were immediately identified. Between 2004 and 2005, State owned firms watched their export drop 153.6 to 96.2 U.S dollar billions. Some companies (like Esquel