A Primer on Currency, Trade, Mortgage Rates
Here are answers to basic questions about the Chinese currency revaluation and what it means for average Americans.
Question: What did the Chinese do?
Answer: They allowed their currency, the yuan, to rise in value against the dollar by 2.1%, with the possibility of further increases in the future. Since 1994, the yuan’s value had been fixed at 8.28 to the dollar. On Thursday, China changed the peg to 8.11 and said it would allow the yuan to fluctuate in value somewhat each day against a group of foreign currencies.
Q: Why did the Chinese keep this peg for so long?
A: Among other things, the Chinese maintained that their financial system was too fragile and underdeveloped to handle the demands of a free-floating currency like more advanced economies such as the United States, Japan and the European Union.
Q: Then why did the Chinese finally revalue the currency?
A: The Chinese were under pressure from numerous countries, including the United States. These countries contended that the dollar peg kept the yuan artificially cheap because the dollar has been weak in recent years. They said that gave China an unfair trade advantage because an artificially low yuan made Chinese goods less expensive in foreign markets.
Q: What’s in it for China to make this shift?
A: Having a more flexible currency will enhance the Chinese government’s ability to regulate the economy’s growth, which is in danger of overheating.
The Chinese also are said to want to be a full-fledged member of the global financial community by the 2008 Beijing Summer Olympics, which they view as their coming-out party to the world. A flexible currency is seen as a prerequisite for being part of the global financial system.
Q: How will the move affect American consumers?
A: A stronger Chinese currency could eventually hit American consumers with higher costs for mortgage loans, fruit juice, toys and many other products, illustrating the U.S. economy’s dependence on inexpensive Chinese-made goods and China’s influence on interest rates. By some estimates, about 14% of U.S. imports are from China. Many American companies manufacture goods in China for shipment to the U.S.
However, to try to keep prices down, American companies might shift some production of goods to other countries where labor and other costs are low.
Q: How could the move lift mortgage rates?
A: Mortgage rates are largely determined by yields on longer-term U.S. Treasury securities. China has been a big buyer of Treasuries over the last decade as part of the effort to maintain the yuan-dollar peg. By shifting to a basket of currencies to manage the yuan’s daily value, China might invest more of its financial reserves in other nations’ bonds. If Chinese demand wanes for U.S. bonds, the Treasury might have to pay more to borrow, driving all interest rates higher.
Q: How could the revaluation help create U.S. jobs?
A: Because a lower dollar and a stronger yuan will make American products cheaper in China, thus encouraging the Chinese to buy more U.S. cotton, copper, soybeans and industrial equipment. That could create jobs at companies exporting those products to China.
Q: Will the revaluation help reduce the American trade deficit with China?
A: The deficit may not fall by much, some experts say, because other countries with low manufacturing costs could simply replace any sales China loses.
