| Future of RMB Essay

RMB refers to the official currency of China that is printed and issued by the monetary authority known as People’s Bank of China. Previously, the value of the RMB was fixed against the value of US dollar. However, this currency was devalued in order to make China become a competitive country compared to the other countries of the globe. It adopted a managed floating exchange system in 2005 in order to ensure that its currency would value. Under this system, the People’s Bank of China (PBC) reevaluated Yuan by about 2.1 percent compared to the dollar. The new figures moved from 8.28 Yuan/US$ to about 8.11 Yuan/US dollar. This bank also announced that it had already formed strategies that would ensure that it tied the value of the Chinese Yuan to a basket of determined currencies. The basket of currencies included United States Dollar, Sterling Pound, and the Euro. PBC wanted the value of the Yuan to fluctuate within a value of 0.3 percent band each day (Zhang, 2011). Most people were happy with the introduction of this system. This is because they claimed that it was a significant step towards ensuring that China had a fully-fledged floating exchange regime. The chamber of commerce of the United States welcomed this move that claimed to ensure that the Yuan continued to estimate the value. This would create strong economic relations between the United States and China.

The RMB estimated significantly in 2012 due to the managed floating exchange rate regime adopted in 2005. It reached a record height that year and financial analysts speculated that it would make the Yuan to reach 6.2 against the United States dollar before the end of 2012. The main reason that caused this was the fact that PBC had been raising the reference rate of the Yuan compared to that of the dollar. After these interventions, the Yuan was able to hit 6.2252 on the spot market, recording the highest value of the Yuan since China opened its domestic market in 1994. The market forces of demand and supply have significantly contributed to the estimation of this currency as well as the widening trade surplus of this country. Economists also claim that the opening of the Capital account of China could further lead to the estimation of the currency. This is because its movement in this country is self enforced and is directed towards the expectation of the market.

The value of the RMB will cause an increase in the cost of Chinese export. Due to this, the short-term profits earned by the major export companies in this country would reduce. According to economists, if the estimation of RMB occurs at a very fast rate, it will reduce the profits of the labor-intensive industries. Some of those companies engaging in exports may even face the risk of bankruptcy. The most affected labor-intensive industries would include mechanical, textile, light and electrical products sector. According to a research conducted by the Export and Import Chamber for Mechanical and Electrical products, further estimation of the RMB by about 3 percent would cause a decrease of about 30-50 percent in mobile phone enterprises, automobiles and home appliances. The Textile Import and Export Chamber states that if the Chinese government estimates the value of the RMB by about one percent, they will record a one percent decline in their yearly profit. This will be a significant blow to the profits that are recorded by the textile industries since the companies make about 3 to five percent profits each year. Companies that are involved in export are also stating that the increase in cost for the labor-intensive industries in this country will make it hard for industrial upgrading to occur. This is because the rapid raise of the exchange rate of the RMB will make it expensive to upgrade industries. If the exchange rate continues to fluctuate frequently, it will make it hard for companies to switch to new end processing means. This is because they would rather stick to their low-end processing means of production in order to avoid foreign exchange losses.

Since the number of exports from China to the United States would reduce because of the RMB estimation, dumping of Chinese goods to the American markets would reduce. United States has imposed strict policies to ensure that China does not dump goods into this country. Recently, the United States Commerce Department raised its anti-dumping measures from 18.32 percent to 249.96 on defective solar cells imported from Suntech Power Holdings Co and Trina Solar Limited. Since the cost of production of labor-intensive industries will increase after the estimation of RMB, it will be hard for companies in this country to dump goods to the United States market since it will be expensive to export such goods. The trade imbalance between the United States and China will reduce due to this.

Background of RMB

Cultural Revolution under Planned Economy

Cultural Revolution occurred in China between 1966 and 1976. This period is important to the Chinese history since it was during this period that the youth in this country decided to go away from the old |s, cultures, ideas and habits. Mao Zedong led this revolution. The Cultural Revolution in China became popular since people wanted to strengthen the economy of China. This is because the Great Leap Forward had weakened it significantly. Due to this, the industrial production of this country fell by about 12 percent. During the Cultural Revolution, China adopted a planned economy. Under which the activities of all the economic units in this country were controlled by annual plans that were formulated in order to ensure that China had a material balance table. The annual plans that were designed at the provincial levels ensured that all the goods in the region were controlled centrally. China had complete control of the all the RMB that it produced in addition to controlling the foreign exchange rates of this country. Economists claim that during the planned economy in the Cultural Revolution of this country, the value of the RMB was placed at an unrealistic value compared to the value of western currencies. In addition, this country put severe foreign exchange rules in order to ensure that its RMB was strong compared to other currencies.

RMB During the “Open Door Policy” in 1978.

The open door policy was created in China in 1978. It was created after the Cultural Revolution since there was a severe economic depression that affected the country. The main aim of this policy was to restore the financial status of China that was to ensure the country was lifted out of restitution. Deng Xiaoping introduced this policy. He realized that it was critical for China to utilize the investment and technology from western nations if the country wanted to improve its financial performance and independence. Previously, China only relied on the USSR as its chief trading partner. The open door policy would ensure that China opened its door to foreign businesses that wanted to start their business operations in China. It created 4 special economic zones in the southern region of the country. In these regions, businesses were offered tax incentives in an attempt of attracting foreign investors. Agricultural reforms were also introduced and this significantly contributed to the great improvement of the general Chinese economy of. During this period, the RMB was supposed to be used only domestically. In contrast, the foreign traders were only supposed to use foreign exchange certificates to conduct financial transactions. The RMB was placed on a dual track system. In 1980, the State Council of this county produced a decree that aimed at preventing foreigners from using exchange as a means of making payments within PRC regions. Foreigners were issued with exchange certificates which they were supposed to use to pay transportation fares, make purchases and pay their hotel bills. A multiple rate structure for the RMB was introduced on January 1, 1981. The rate introduced during this time stood at RMB 2.80 per one US Dollar.

RMB During the 1998 Global Financial Market

The global financial market of 1998 was affected by the Asian financial crisis that happened between June 1997 and January 1998. It affected countries such as Indonesia, Singapore, Hong Kong, Thailand, Malaysia and South Korea. Prior to the financial crisis, these countries recorded positive returns since they showed expanded economic growth of about 6 to 9 percent each year. The crisis began after Thailand started experiencing a meltdown. Some of the big property developers in this country were unable to make their interest payment for huge loans. Somprasong Land failed to pay $ 3.1 million interest on its $ 80 billion loan. In addition, the stock market in this country recorded a decline in activity by as much as 45 percent. Poor financial performance in this country made its finance department to seek assistance from the International Monetary Fund (IMF). The debt problem in South Korea also increased significantly. Financial crisis in Japan caused its major stock brokerage firms to file for bankruptcy because they recorded huge capital losses. The loans that were taken in the bubble years in this country also started performing poorly. Moreover, some of the financial institutions closed their operations. The financial market crisis in Asia made the Chinese government to formulate policies that aimed at ensuring that RMB traded with other currencies within a narrow band created by them. This is because China was concerned that its financial systems would not be able to handle the hot currencies that moved from other Asian countries facing financial crisis. In addition, China did not depreciate its RMB that helped in stabilizing the economy of this region and prevented it from becoming worse.

RMB When China Entered WTO in 2001

China entered the World Trade Organization in 2001. It succeed in entering the WTO after the Chinese government and the PRC pushed for its membership in this organization. One of the reasons that caused other countries to include China as a member state in this organization was the fact that it improved its laws and general administrative regulations. Some of the significance laws that China revised in order to ensure that it entered the WTO included the Trade Mark Law, Law on Joint Ventures with Chinese and Foreign Investments and Law on Chinese-Foreign Cooperative Ventures. Other laws that were revised include Laws on Foreign-Funded Enterprises, Patent Laws and Law on Chinese-Foreign Cooperative Ventures. This had several impacts to the RMB. After China entered the WTO, it started to consider the option of making its RMB convertible. In addition, it planned to depreciate its RMB in an attempt of making it escape the negative effects of the global economy. When it joined the WTO, it stated that it wanted to speed up the considerations of introducing a fixed program on its currency exchange rate. Before it entered the WTO, its RMB was under a managed float. It only fluctuated within a small bad compared to the US Dollar.

China Government Stimulus Package of 4 Trillion RMB

China introduced a 4 Trillion RMB stimulus package in order to increase its domestic consumption. This package was introduced in 1998 in order to ensure that China was not significantly affected by the global financial crisis. In this stimulus package, China was to increase its spending on the construction of low cost houses. In addition, it wanted to spend the money that was gotten from the stimulus package to finance the construction of new infrastructure in this country. Chinese government also planned to spend the new funds that it got for the improvement of passenger transportation system, new railway system in the west and the improvement of the government airports in this country. They also increased its overall spending in health and education that, as it was believed, would lead to an improvement in the general economy. The stimulus package also introduced reforms in its value added tax systems to ensure that it was able to reduce its industrial costs by about 120 billion RMB. Under this stimulus package, the credit ceilings of all the commercial banks in this country were eliminated. This was in an attempt of ensuring that lending priority was given to the small enterprises in this country, rural projects and technical innovations.

Local Government Investment with the 4 Trillion RMB

The local governments in this country were supposed to spend the money from the stimulus package to finance projects such as building of roads, schools and health care facilities. However, economic experts warn that the local government is spending the funds inappropriately. The local government of the province of Changsha, capital of Hunan province, spent about 829.2 of the stimulus package to finance some of the infrastructural projects in this country. Banks of this country were encouraged to lend to the local governments under the 4 Trillion RMB stimulus package. However, this was a significant risk since some of the local governments had a poor credit rating increasing their chances of defaulting paying the loans that they had borrowed. In 2008, the Ministry of Finance of this country was struggling to find 173 billion US dollars to support the stimulus project proposed by this country (Jeffries, 2010). In order to raise these funds, the Ministry of Finance of this country gave local governments the consent of selling publicly owned land. The sale of lands by the local governments in this country could raise about 46 percent of the revenues raised by them. This was not an appropriate way of raising funds since cases existed where local governments were accused of acquiring land illegally to sell it and earn revenues. In addition, the prices of the houses in this country increased because of these transactions.

The local governments of this country wer also accused of conducting illegal transactions using money from the stimulus funds. The local government of Guangdong province was under the spot light in this case since they allocated funds to several projects despite the fact that they were not given any legal authority. They allocated 570 million United States dollars to fund tax concessions, unemployment benefits and investment finance. No legal authority could justify this funding. Reports from the National Audit Office in China also revealed that they were investigating 84 $ billion that were borrowed by one of the local governments in this country to finance the acquisition of vehicles. This is because there were a possibility these funds could have been misappropriated. This shows that the local governments of this country did not efficiently allocate resources.

According to financial analysts, the inefficient use of resources by the Chinese local governments could expose this country to the risk of facing bad debts. From 2009 to 2012, the Chinese banks issued about 35 trillion Yuan in new loans in order to provide financial support that would boost the stimulus package. This is about 73 percent of the GDP of China in 2011. However, there is a high risk that this would fuel the chances of development of a property bubble. In 2010, the PBC saw the risk that this country faced because of the massive debts that it was taking. However, the local governments in this country had already taken advantage of the cheap and lose credit since they took huge loans. Most of the loans that were taken by them were wasted in funding prestige projects. In some instances, the funds were used to finance economically wasteful projects that did not show any future of yielding positive returns. According to the National Audit Office of China, the outstanding local government debt of this country totaled to bout 10.7 trillion RMB. In addition, the local government-financing vehicle (LGFVS) of this country had a debt of about 9.7 to 14.4 trillion RMB at the end of 2010. LGFVS are financial entities that were established by the Chinese local government to invest in projects such as building of infrastructural projects.

Effect of United States Trade Deficit on RMB Depreciation

Currently, the United States of America has a trade deficit. In 2012, United States recorded a trade deficit of about 44448 $ million. Economists claim that this trade deficit is largely contributed by the fact that America heavily relies on petroleum imports. In 2012, America imported about $ 313 billion in petroleum related products. This was a huge increase compared to the imports that this country recorded in 2010 of about 252 billion (Liu, 2012). The rise in demand for consumer products and automobiles in this country also contributed to the rise of America’s trade deficit. In 2012, this country imported $298 billion worth of auto trucks, cars and parts. In contrast, it only exported cars that were worth $ 146. It shows that United States ran on a deficit in the trade of cars. Consumer products of the United States also contributed to the trade deficit in this country. In 2012, the demand for household goods, clothing, furniture and consumer electronics caused the United States to run on a deficit of about $ 335 billion. This is because it imported about 516 billion dollars worth of these products while it only exported $ 181 billion dollars of such products.

The trade deficit of the United States would cause the RMB to continue to depreciate. This is because the trade deficit in the United States will lead to depreciation in the dollar value of this country. Since the US Dollar is among the currencies in the basket of currencies that determine the value of the RMB, there is a very high chance that the RMB value would depreciate (Feldstein, 2008). China significantly benefits if the US Dollar performs well. This is the main reason that the trade surplus of China rose from 83 $ billion in 2001 to about 258 $ billion in 2007 before the global recession occurred in 2007 because of the good performance of the US Dollar. However, the trade deficit in the United States has caused the Dollar to fall against the RMB, Euro, Brazilian Real and the Australian and Canadian Dollars. Since China has an undervalued exchange rate policy, the US Dollar has continued to depreciate significantly due to the fact that this country has a trade deficit.

United States Trade Deficit and Growth to China’s GDP

When China joined the WTO, its trade relationships with the United States increased. However, United States piled up its foreign debt in order to ensure that it remained competitive in the global trade and this made it lose its export capacity. The amount of revenue that this country earned from exports reduced because of this. However, China’s GDP has grown due to the trade deficit in the United States. Some of the workers in the manufacturing sector of the United States government have lost their jobs. However, these jobs end up being given to low wage workers from such nations Chinese that has caused the GDP of China to improve. The trade deficit in the United States has also been caused by the fact that this country imports computers and electronic products from China. 54.9 percent of the trade deficit in America between 2001 and 2011 was caused by the import of computers, semiconductors, audio-video equipment and other electronic products coming from China. These imports made the GDP of China grow since the local Chinese people were employed in the industries engaged in the manufacture of the electronic products. The trade deficit in the United States was also caused by the fact that it heavily relied on the importation of technology from other countries such as China. China’s GDP grew since it was responsible for the production of the latest biotechnology discoveries. In addition, its innovation in the aerospace and nuclear technology also caused its GDP to grow since it exported the discoveries to other countries just as the United States.

The economy of China is overheating due to China expanding at a very fast rate since 2010. That year, the economy of the country increased by 9.8 percent of the final of 2010. The overall economy of this country improved by 10.3 percent during the entire year. The main driver of inflation that caused the overheating of the Chinese economy is the increase in food prices of China. Chinese food prices rose by about 7.2 percent in both 2010 and 2011. Beijing has started imposing measures to ensure that the economy of China does not overheat further. One of the measures that it has adopted is tightening the restrictions that are imposed on bank lending. In addition, it has also increased its agricultural subsidies.

Economic experts are warning that China is heading to a housing bubble. For the past 30 years, the Chinese government has invested heavily on the real estate market and developped properties in an attempt of stimulating the economic growth of this country. Some analysts are claiming that the housing bubble that might occur in China will be the mother of all bubbles. The fear that China might face a housing bubble has caused the shares of cement producers, construction companies and real estate developers to reduce in the recent past. This has caused Beijing to implement strategies in order to prevent the bursting of the Chinese bubble. One of the rules that was imposed was including a 20 percent gain on the sale of all properties in this country. The down payment of all the mortgages borrowed in this country has also been increased. Moreover, China faces the risk of bursting of its stock market bubble. Between 2006 and 2008, the share prices of China rose by more than 500 percent. Tock analysts warned that this rise was making the stock market to run wild. Everybody was trying to invest their funds in the stock market since they felt that they would earn significant returns. However, the rise in demand for shares caused the price of the share in this country to increase by more than 20 times. The huge demand for shares in China’s stock market caused the Shanghai composite index to plunge by more than 45 percent. Most people started to try selling their shares at a loss creating a bubble. There is a significant risk that this situation may happen again. This is because the performance of the Chinese stock market has been very positive making investors to rush to put their investments into the market.

Why FDI Results into Devaluation of RMB

Foreign direct investments would result into the devaluation of the RMB. Most nations in Asia are moving to China to conduct their foreign direct investments since the RMB has been performing very well compared to the basket of currencies from other nations. The share of China’s foreign direct investments rose from 25 percent in 1997 to 37 percent in 2008 showing that this country is becoming a popular FDI destination. In the long run, the country may be forced to devalue the RMB in order to make it a more attractive destination for FDI. This is because it may be forced to lower its exchange rate in an attempt of making its currency to be at par with its neighboring countries so that they can conduct good trade relationships. China will need to devalue its RMB in the long run to become equal to the other middle income neighbor currencies.

Conclusion

Overall, China needs to revalue the RMB in order to guarantee that this currency has a positive future. Currently, China uses the managed floating exchange system that it adopted in 2005 for the currency to remain competitive compared to the other currencies in the globe. The PBC revalued the RMB so that it estimated by 2.1 percent compared to the value of the US Dollar. However, continued estimation of the RMB is dangerous since it will cause an increase in the cost of Chinese export. The short term profits that are earned by the labor intensive industries in this country would reduce. Some of the industries may even face the risk of bankruptcy since they may not be able to finance the high cost of operations. However, the adoption of the managed floating exchange has caused the economy of China to perform better compared to the period of Cultural Revolution and during the open door policy. Its present value is also better compared to the value that this currency had during the 1998 global financial market.

RMB started improving when the Chinese government entered the WTO in 2001. It entered this organization in order to boost its foreign trade and improve its overall international relations with other countries. China also adopted a stimulus package in order to boost its economic growth and development. In this stimulus package, the Chinese government planned to spend 4 trillion RMB in an attempt to improve its infrastructural projects. The local governments played a critical role in managing the funds that were raised to fund the stimulus project. However, they failed in their part since evidence has indicated that some of them mismanaged the funds from the stimulus package. They were forced to sell the local land in order to raise enough funds for financing the stimulus package. Due to this, the local governments exposed China to the risk of facing bad debts due to the amount of RMB they wasted for funding expensive projects that were not economically viable. The trade deficit in the United States causes the value of the RMB to continue depreciating. The main reason for this was that it caused the value of the US Dollar to reduce making RMB to be at a risk of depreciating. However, the trade deficit in the United States has caused the GDP of China to increase. This is because the trade deficit in United States was caused by the fact that it imports many products from China some of which include computers, automobiles and other electronic appliances. Such importations boost the overall growth of the Chinese economy.

However, experts are warning that China might be heading to a housing bubble. China has invested a lot of funding into the property market. The stock of cement producing companies and property markets have been reducing due to the fear that this country may face a housing bubble. In addition, the stock market in this country also faces the risk of being affected by a bubble.