However, most forex traders look at the yuan/dollar exchange rate the opposite way. In other words, a dollar is worth 6.3080 yuan. By the way, this is its highest level in 17 years. China is allowing the yuan to gradually rise to slow export growth and offset inflation.
Is China Guilty of Currency ManipulationDespite the yuan's controlled rise, many analysts think the Chinese government keeps the yuan artificially low. China does this to keep its products cheaper than U.S. products, thus increasing its exports to the U.S.
Some analysts say the yuan needs to rise 30% in value. They argue that if China allowed the yuan to float freely, it would be more valuable than the dollar because of China's strong economy. However, others argue that the yuan has already appreciated 25% against the dollar since July 2005.
The yuan has risen 6% annually, which converts to 10% due to China's higher inflation. This is a healthy rate of increase -- any more would have negative economic impacts for China. The country is desperately trying to keep its 1.3 billion people employed to raise their standard of living. China's leaders are afraid they will revolt if growth isn't fast enough. Even though China is the world's third largest economy, ($10 trillion, right behind the European Union and the U.S.), its GDP per capita is only $7,600. This is worse than much smaller countries such as Jamaica or Ecuador.
How Does China Keep the Yuan at a Fixed Exchange Rate?In a world of volatile foreign currency movements, exactly how does China maintain a fixed exchange rate? First, China promises to redeem dollars for yuan at the fixed rate. To do so, it must keep a good supply of dollars in reserve. Instead of holding dollar bills, it holds U.S. Treasuries, which it can quickly sell for dollars. As China's economy grows, it must buy more and more U.S. Treasuries to meet the growing number of yuan. As a result, China is the largest holder of Treasuries.
In November 2011, China held more than $1 trillion in U.S. debt. This makes the U.S. a little more vulnerable to China's political pressures. For example, in 2009 China called for a new global currency to replace the dollar. China was concerned because the dollar's value was declining, a result of the U.S. flooding the world with dollars to boost is own economic growth. China rattles its sabers like this whenever it sees its holdings of dollars lose value.
China's Yuan Policy Keeps the Dollar StrongRight now, the dollar is used as the currency of choice for most international contracts. All oil contracts must be transacted in dollars. This has been the case since the U.S. went off the gold standard in 1973.
The dollar being the world's global currency is one reason the U.S. debt has grown so large. It keeps the dollar in demand, thus keeping Treasury interest rates low. In a way, China's desire to keep the yuan low makes it buy U.S. Treasuries. This keeps yields low, which helps the U.S. housing market by keeping mortgage rates low. For more on how this works, see The Relationship Between Treasury Notes and Mortgage Interest Rates.
Will China's Yuan Policy Change?China could, theoretically, threaten to sell its Treasury holdings, putting the value of the U.S. dollar into freefall. However, it's not in China's best interests to do so. By threatening to sell U.S. Treasuries, China would quickly devalue its own holdings. Even so, it's been unwise for the U.S. to allow itself to become so indebted to any other country.
China has allowed some limited forex trading in Shanghai. To let the yuan freely float, China should allow all its residents to hold foreign currency and buy foreign assets. This would allow the Chinese Government to hold less dollars and lessen the trade imbalance with the U.S. Then there would be less focus by the U.S. Congress calling for an increase in the yuan's value. (Article updated January 31, 2012)