Exporting Countries and Currency Pegging

As a continuation of discussion from class. I would like to go a little bit further on our analysis of currency and net exports. I want to focus mainly on China as the Chinese Yuan seems to be the issue that comes up again and again in both US and China.

On a detour to talking about China, let us first explore what other exporting countries are doing. To list a few, Germany, Russia South Korea, Singapore, UAE and Saudi Arabia are included in this list. We can find some common factors in this list. Although they are not fully listed here, most countries with large reserves tend to run surplus. Unless the country consumes more oil than it produces like US is doing, this is quite intuitive as oil and natural gas demand everywhere in the world. Other countries are almost exactly the opposite. They do not have such big endowments in natural resources, but they have competitive edge in a very focused industry or other technology that the rest of the world demands. Germany or Korea would fall under this category.

These countries are very sensitive to exchange rates. Take Korea for example.

MyChart (Data: World Bank)

 

Export of goods and services to GDP ratio takes up 57% of GDP on 2012 (import lingers around 50%). Export industry is a big part of Korean economy and is very sensitive to even the slight changes in exchange rates. Any sudden increase in exchange rates will have enough power to scare people and voice their worries.

Now, let us explore how exactly exchange rates influence these countries. Like we have discussed in class, net capital outflow which determines the supply of currencies in a given country, ultimately gives the the exchange rate. Suppose there is a monetary expansion in the Fed that lowers interest rate. Capital in the country will flee to other countries like Korea. In US, supply of dollar will increase, and the exchange rate will decrease. Lower exchange rate would mean that it is cheaper to buy American goods now for Koreans, and net export will increase as a result. As for Korea, there is a negative shock in NCO, which also influences the supply of KRW in a negative direction. Exchange rate for KRW / USD will increase and makes Korean goods seem more expansive for American consumers. Net export decrease for Korea as a result.

How is China coping with this situation then? China is pegging Yuan to the Dollar, meaning regardless of the shocks in the US’ capital inflow or outflow, China is maintaining the value of the exchange rate so that it is exporting at a very consistent level. China is able to do this because they are buying large amount of US treasury bonds to maintain the NCO level. China, the so called ‘factory of the world’, is exporting capital goods at a global scale and seemed to have chose the right strategy to rely on net export for growth motor. While it is completely impossible to peg Chinese Yuan to US dollars, China has been increasing the amount of swing in the exchange rate gradually. Rates have doubled on January 2012 from 0.5% to 1% and once again this year from 1% to 2%.

US has been complaining about the trade deficit with China for a long time. Although we do not know the true value of Yuan– at least not yet because they have been pegged to USD– China has been gradually reducing constraints on this matter. I personally think that China is taking its time to really detach itself from the exchange rate peg. High level of government surplus due to cultural habit of high savings rate adds to the NX disparity between US, but China is not willing to spend this money just not yet for export’s sake. After all, although their total GDP is quite high, China’s per capita GDP is not very close to any of the OECD members. Perhaps China will be more open to free floating rate once they deem themselves at a similar playing level with other countries.

One thought on “Exporting Countries and Currency Pegging

  1. awerther

    Nice post. Your analysis that corresponds to the international finance graphs in class is very clear and easy to follow. It will be interesting to see what China does in the near future regarding their exchange rate.

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