Why the Chinese Will Not Revalue the Yuan

In China, much like in many Asian countries, the local currency, the Yuan, has had a fixed exchange rate to the dollar for many years. Historically, the value of this exchange rate was entirely under the control of the government, a fact which gave them great control over the way in which money flowed in and, more importantly, goods flowed out of the People's Republic. There has been growing pressure for more than a few years for the Chinese government to release their control of this exchange rate and to allow it to move, in the natural course of market trading, to a more freely determined level. The Chinese government, one must assume reluctantly, in 2005 allowed this to begin to take place, by fixing the rate of the Yuan to a secretive "Basket" of currencies that would be designed to allow the overall exchange rate of the Yuan to move more freely. However in the almost 2 years since this took place, relatively little movement has been seen in the value of the Yuan, and the Chinese are facing calls to devalue their currency further. The interesting question here is what do we expect the future to hold for the Yuan? To understand this we need to understand why the Yuan is valued the way it is at the moment, what the impact of a revaluation might be on Chinese economics, and what are the consequences of doing nothing.

For many years the growth of the Chinese economy has been one of the most impressive stories of global economics, averaging 9% GDP growth per year for the decade to 2004. This growth shows no sign of stopping, and is a major driving force behind the urbanisation and modernisation of Chinese life. It is a testament to how far the Chinese economy has progressed in the recent past, that a country which suffered food shortages and starvation in the previous generation is now in the unprecedented position of being talked about as overtaking America as a global economic superpower in the next generation. The smartest and hardest working Chinese students can afford jet half way around the world to study at the best universities, paid for by their now wealthy parents - the same ones that may have suffered hunger themselves not so long ago - and who know very well that China's new found wealth should be held on to and respected for the better life it can bring their children.

The engine of China's economic growth has been manufacturing, and, more specifically, the revenue generated by exporting those manufactured goods to wealthier countries. First of all, it is interesting to note that around 20% of exports from China to go the US, and are predominantly in manufactured goods; items such as electronics, office equipment as well as clothing and textiles make up just over half of all Chinese exports. Clearly there is a large vested interest in manufacturing and exports; the manufacturing side is driven by a large availability of cheap labour (China is the worlds most populous country, and around half those people work in agriculture), and exports create revenue by virtue of their affordability to a large number of people around the world. It is this affordability which the Chinese government are looking to control when they manage the exchange rate of the Yuan; and if managed correctly, their exports and associated revenues will continue to grow, and be a boon to the lives and well being of the Chinese people, leading them to the greater prosperity and comfort which all people strive for. Clearly therefore it is in the interests of policy makers in Beijing to attune the exchange rate of the Yuan to suit the needs of the Chinese people - although they may not be democratically elected, the government must keep the needs and wishes of the Chinese people foremost in mind when making strategic decisions - and this will always therefore lead them to keep the Yuan low enough to stimulate growth, particularly in the form of those exports to richer countries that bring in valuable foreign money, which is the main reason for the growing prosperity of modern China.

Therefore, we can expect that the future will not bring any major revaluations of the Yuan - the Chinese government has been under pressure for some time now to devalue the currency, but has not done so in any significant fashion, and we should expect this trend to continue as long as no extraordinary external pressures force it to do otherwise. That the Chinese have allowed the Yuan to float freely at all has been in response to strong criticism, particularly from the US, that the currency is too weak. The fact that the Yuan has only moved around 5% in the last year, when some in America are calling for a 40% revaluation, shows how reluctant the Chinese are to concede to these demands - it is from this that we can infer that the decision was taken reluctantly, and that the Chinese will resist as much as possible any further requests to devalue the Yuan further.