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Business in China

Essay by   •  June 11, 2011  •  Case Study  •  685 Words (3 Pages)  •  1,557 Views

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First of all, flexible exchange rate of Reminbi will decrease the imbalances of current account surplus and improve utilization of capital. Although the current account surplus of China had decreased during the financial crisis, however, after the crisis the current account surplus has been proved to rebound. At the same time, the foreign currency reserve of China has reached to 2.5 trillion U.S dollars, these assets seem not quite valuable to Chinese economy but to continually support the U.S government's borrowing.

The traditional views on the causes of China current account surplus can be explained by five reasons. First of all, measurement errors, the "hot money" can be by counterfeited exports, this behavior will overstate the surplus amount. Secondly, the high saving rate can allow banks to lend money to corporations for investment, and those corporations have to export their goods to digest their excess production. Thirdly, reallocation of industries from East Asia to China also transfer trade surplus to China. Fourthly, government policies have promoted the GDP growth, exports and full employment thereby inflating the surplus. And finally, exchange rate distortion also raises exports and discourages imports.

Appreciation of RMB will encourages imports and depress exports. However, the appreciation needed to be controlled in a safe range, if the RMB appreciates too fast the possible outcomes would be : 1) the foreign corporations will shifted their production plants to other countries that can provide lower costs for production, such as India and Vietnam. 2) the imported countries have to bear the higher costs, and these costs will be transferred to consumers and possibly will cause a higher inflation. Therefore, in order to control inflation, governments need to tight up the monetary supplies and this action will harm the recovering process of their domestic economies, especially for the United States, which will dramatically influence the economy of China.

Secondly, the increase of flexibility of currency exchange will provide security of the independence of Chinese currency policy. What China does at the moment is to maintain the stability of foreign exchange rate and independent currency policies but to give up the free flow of capital, however, as the effectiveness of the governance of capital items of China has been weakened therefore cross-boarder capital flow, especially hot money has already influenced the independence of Chinese currency policies. Massive capital inflow to domestic capital market creates excessive liquidation and also creates impacts on achieving the goals of PBOC's currency policies.

Thirdly, for the reason that China is one of the most influential economy in the world now and its policy decision would bring significant influences on the global markets, appropriate appreciation of currency will allow China to avoid the criticism

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