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Q: Governments altering currency value. ( Answered,   3 Comments )
Subject: Governments altering currency value.
Category: Business and Money > Economics
Asked by: rico77-ga
List Price: $25.00
Posted: 22 Jul 2005 18:07 PDT
Expires: 21 Aug 2005 18:07 PDT
Question ID: 546794
What mechanisms does a government have to raise/lower its currency
value? China has recently raised the value of the yen relative to the
dollar. How? What are the implications?
Subject: Re: Governments altering currency value.
Answered By: omnivorous-ga on 25 Jul 2005 12:23 PDT
Rico777 ?

The Chinese move to allow the yuan to appreciate upward to 8.28 per
dollar, after fixing it at 8.11 for years, is still being digested by
markets.  However, it?s an interesting look at monetary policy as
practiced by the central bank of a country.

To the core of your question -- it?s a clear difference between a
fixed-exchange rate economy (China) and one that allows floating
exchange rates.  China can only buy or sell currency to raise/lower
the currency value.  A floating exchange rate country can do many more
things ? buy/sell foreign currency; change its interest rates and
money supply; manage credit quality ? and many other things (see the
?Monetary Policy? section of the Wikipedia article, referenced below).

Wikipedia?s article on monetary policy discusses how interest rates
and the money supply works.  It makes a key point in the section on
the Central Bank: ?If the exchange rate is pegged or managed in any
way, the central bank will have to purchase or sell foreign exchange.
These transactions in foreign exchange will have an effect on base
money analogous to open market purchases and sales of government debt;
if the central bank buys foreign exchange, base money increases, and
vice versa.?

?Monetary Policy ? Trends in Central Banking?

The Chinese had indeed been purchasing dollar-denominated bonds.  The
impact within China was to increase the money supply, potentially
feeding inflation (though it has not been a serious problem within
China, as productivity is increasing).

With the change last week, the first impact was in the bond markets ?
with a decrease in prices and increase in yields.  The Wall Street
Journal this morning notes that ?China could feel less need to buy
dollars to hold the yuan down.?  The impact: high yields on everything
from Treasury bills to corporate bonds to mortgage interest rates. 
The same Wall Street Journal article asks, ?Could China prick the
housing bubble?,? referring to the current rapid appreciation rate for
U.S. housing.  It also notes that utility stocks declined after the
Chinese announcement, primarily because that industry?s stocks are
valued for their bond-like dividend yields.

What else happens with the upwards valuation of the yuan?
?	imported American foods or raw materials are less expensive for Chinese consumers
?	dollar-denominated goods, such as oil, is cheaper in China
?	Chinese manufactured goods are all more expensive, leading to
cost-push inflation in the U.S.
?	If a Chinese company is in the process of buying an American
company, as is being proposed by Cnoc (buying Unocal) or Qingdao Haier
(buying Maytag, an offer now withdrawn), the purchase price is lower. 
It could to a rash of acquisitions by profitable Chinese companies.
?	Exports in China make less in yuan
?	Outsourcing of products or services to China are less attractive
?	Chinese firms are worth more in dollars,
?	Earnings for U.S. multi-nationals in China are worth more when
profits (and assets) are translated back into dollars

You might want to see today?s Wall Street Journal and the article
titled ?Yuan Move Might Stir Big Ripples.?  It largely says that it?s
impossible to know what the long-term impact will be without knowing
what FUTURE moves of the yuan might be.

Google search strategy:
?monetary policy? + central bank

Best regards,

Subject: Re: Governments altering currency value.
From: financeeco-ga on 24 Jul 2005 01:46 PDT
There is always a 'free' (floating) foreign exchange market between
currency X and currency Y. When a country acts to control its exchange
rate, it simply enters that free market as a buyer or seller (as
necessary) in order to move the supply/demand equilibrium to the
government's desired price target.

For example, China had pegged ~8.28 per $. The free market rate
should've been higher (there was upward pressure on that price), so
China stepped in to add excess supply. By printing new yuan to sell on
the market, China could pour however much currency into the forex
market as was necessary to move the equilibrium peg back to its

At some point, the market accepts a country's peg psychologically, and
it becomes much easier for a country to hold the peg. In a sense, it's
self fulfilling. As long as the market belives the country will hold
its peg, the peg holds. When the market stops believing the country
can hold the peg, the market usually overpowers the country and breaks
the peg.

In general, a government can always lower the value of its currency
(by pouring more money onto the market). It is much harder to prop up
the value of its currency, because doing so requires purchasing one's
own currency with existing foreign exchange reserves. When those
reserves run out, the peg is broken and the currency falls.
Subject: Re: Governments altering currency value.
From: financeeco-ga on 25 Jul 2005 21:31 PDT
The previous answer got a few numbers wrong... the OLD peg was
~8.28/$. The yuan will rise to 8.11/$. The numbers seem backwards at
first, so think of it this way: it used to cost 8.28 yuan to buy a
dollar bill. Now, it only costs 8.11 yuan. Fewer yuan buy the same
thing (one dollar), thus the yuan has appreciated and the dollar has

Also, China had all of the policy tools that a floating-rate country
has. The only difference is that China (used to) openly declares its
intent to intervene in the global foreign exchange market as necessary
to achieve the desired peg.
Subject: Re: Governments altering currency value.
From: omnivorous-ga on 26 Jul 2005 06:56 PDT
Financeeco -- good catch on getting the exchange rates backwards.  But
the point about policy tools was simply that they can be used to
change exchange rates in a country like the U.S. -- where in China the
only tool available is official policy and buying/selling of currency
or bonds.

Best regards,


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