“There was a frenzy of speculation about Chinese currency devaluation earlier this year after a series of surrise moves that weakened the yuan (also called the renminbi) against the dollar. For all the discussion, the yuan has fallen by only about 3% in value against the dollar in 2015.
McKinsey estimated that Chinese debt has quadrupled since 2007 and its debt to GDP ratio has risen above that of the US. The question is, given the semi USD/RMB peg and China’s increasing open capital account (which come at the expense of China’s monetary independence), whether China can live with higher US interest rates and a higher US dollar. A weaker currency generally would boost China’s export potential and might help to prop up its flagging growth figures.
The yuan has actually strengthened in general over the past decade. It is still up by about 6.5% against the greenback since the middle of 2010 and up by 22.8% in the past 10 years, since the currency was unpegged from the dollar in 2005.
But before that period of pegging, you can see how massively the currency was devalued over a 15-year period, rising from less than two to the dollar in the early 1980s to over eight to the dollar by 1994“.
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Currency fluctuations are a natural outcome of the floating exchange rate system that is the norm for most major economies. The exchange rate of one currency versus the other is influenced by numerous fundamental and technical factors. These include relative supply and demand of the two currencies, economic performance, outlook for inflation, interest rate differentials, capital flows, technical support and resistance levels, and so on. As these factors are generally in a state of perpetual flux, currency values fluctuate from one moment to the next. But although a currency’s level is largely supposed to be determined by the underlying economy, the tables are often turned, as huge movements in a currency can dictate the economy’s fortunes. In this situation, a currency becomes the tail that wags the dog, in a manner of speaking.
Currency Effects are Far-Reaching. While the impact of a currency’s gyrations on an economy is far-reaching, most people do not pay particularly close attention to exchange rates because most of their business and transactions are conducted in their domestic currency. For the typical consumer, exchange rates only come into focus for occasional activities or transactions such as foreign travel, import payments or overseas remittances.
A common fallacy that most people harbor is that a strong domestic currency is a good thing, because it makes it cheaper to travel to Europe, for example, or to pay for an imported product. In reality, though, an unduly strong currency can exert a significant drag on the underlying economy over the long term, as entire industries are rendered uncompetitive and thousands of jobs are lost. Read more »