Why China Manipulates the Yuan

It's a well-known fact China intentionally manipulates the value of its currency. What's less understood is exactly how and why it does so.

For years, analysts and commentators have been calling on the U.S. government to do something about this. "China's policy of keeping its currency, the renminbi, undervalued has become a significant drag on global economic recovery," Paul Krugman argued in 2010. "Something must be done."

Although the controversy faded soon after Krugman's plea, it resurfaced at the beginning of this week. On Monday, the Chinese central bank weakened its daily reference rate for the renminbi (which is also known as the yuan) by the largest percentage in more than a year and a half.

The reason? According to The Wall Street Journal, "Beijing is seeking to make it clear to investors that the yuan isn't a one-way bet, laying the groundwork for allowing the currency to trade more freely." It was, in other words, a naked attempt to stamp out unfriendly currency speculators.

For people who don't follow the currency markets, the revival of this debate begs two questions: Why does China manipulate the value of the yuan? And how does it do so? In the presentation below, Motley Fool contributor John Maxfield answers both.

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Read/Post Comments (10) | Recommend This Article (27)

Comments from our Foolish Readers

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  • Report this Comment On March 13, 2014, at 6:00 PM, xetn wrote:

    Another idiotic article. China, like every other country with a central bank, manipulates their currency in the belief it will gain an advantage in exports.

    They accomplish this task by creating new currency which enters the market place via bank deposits or through purchase of "assets" such as government debt.

    They are all in a race to the bottom.

    While this practice may temporarily gain an advantage, it caused domestic prices to increase. In essence, the residents of the country are subsidizing their country's exports.

  • Report this Comment On March 14, 2014, at 10:43 AM, Handyman111 wrote:

    For a more detailed explanation of the "race to the bottom", see James Rickards book Currency Wars: The Making of the Next Global Crisis. I think China's printing of currency is barely keeping up with our central bank.

  • Report this Comment On March 14, 2014, at 11:57 AM, observerbob2013 wrote:

    China manipulates the currency to benefit China. Simple.

    The West has been following flawed economic models that ignore the fact that a government should act in the interests of its citizens in both the short run and the long run.

    There is a short run benefit is giving away your manufacturing industry and jobs, cheap consumer goods, but surprisingly there is a long run result that transfers your wealth to another.

    Hence China banks dollars while the US gives them away for useless gadgets

  • Report this Comment On March 14, 2014, at 12:19 PM, SMFT wrote:

    How do you lift 1.3 Billion out of poverty?

    You've just shown us. A centrally-planned economy where the government moves the currency in it's own favor. As social-economic experiments go, it has been massively successful. You cannot fault them. You cannot blame them. It was the best and smartest thing they could do with a massive, unskilled population base.

    To quote Pearl Bailey, "It takes two to tango", if we didn't buy all those cheap exports, they wouldn't have the marketplace for them. I managed my childhood without a Ninja Turtle battle-shell or whatever. Just hand-me-down clothes and toys.

    If not for China's dollar-buying, the U.S. economy would be in deep doo-doo with high interest rates and decreasing currency valuation..... it has been a general win-win for both sides.

    $50 per-hour U.S. factory workers were never going to be globally competitive in the 80's and 90's, whether or not China did what it had to do to lift its population. If not China, then Russia, or Brazil, or India, or Sri Lanka, or.... etc. etc. would have filled the void.

  • Report this Comment On March 14, 2014, at 12:22 PM, oceaqua wrote:

    This piece looks like the econ assignment of a high school student.

  • Report this Comment On March 17, 2014, at 10:25 AM, bytre wrote:

    not a helpful article.

  • Report this Comment On March 20, 2014, at 11:23 AM, Johny205 wrote:

    Printing money may help boost exports, thereby boosting the economy, but it also devalues their currency. I would be pissed of if I had a lot of money in the bank, trying to live off the interest income and the government kept on devaluing my money! But I don't have a lot of money in the bank, so I don't need to worry about that.

  • Report this Comment On March 21, 2014, at 5:32 PM, luhen wrote:

    All countries attempt to influence the rates of exchange of their currencies....Again, a bit of honesty AND knowledge might be helpful in facing realities...

  • Report this Comment On March 24, 2014, at 6:09 PM, 4Prophet wrote:

    Hi John,

    Matching up your charts with your thesis isn't as simple as presented (to me at least). The big drop in Yuan between 80-95 is met with hardly a blip in the US reserves held by China over the same period. Similarly, the buying power has been basically level since about 1994, while the reserves have expanded wildly over the same period. A clarification would be appreciated.

    Thanks

  • Report this Comment On March 26, 2014, at 6:15 AM, rafarules wrote:

    John,

    Have to second 4Phophet just to start - your analysis is very, very flawed. For starters try applying your thesis to the Hong Kong currency manipulation policy and see if the same logic fits. There is no correlation between the value of one's currency and one's GDP. Try measuring GDP in terms of unit output instead of in terms of currency and you'll learn far more about GDP. Measure the value of the US dollar over the same period versus a European currency and see what conclusions you can infer. Finally, your chart on the purchasing power of the renminbi is far off, which might be attributable more to the errors of your source than yourself.

    Anyone who has been to China recently knows the purchasing power of the renminbi has fallen dramatically over the past three years DESPITE the value of the renminbi having risen over that same period versus the US dollar and other currencies. It's a primary reason the U.S. has not experienced comparable inflation - the US has successfully exported inflation to China and other lesser developed nations even as the US has allowed the value of our dollar to fall, thus escaping the downside effects of our massive printing press.

    Production will naturally shift toward sources of cheaper labor & materials. Thus, from England to the US to Japan to Hong Kong to South Korea to China and eventually to other Southeast Asian countries to South America and Africa and the Middle East and eventually to other planets on nearby solar systems. This is all independent of the relative value of the currencies with respect to each other.

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