The Chinese yuan has had a currency peg since 1994. This approach makes Chinese exports cheaper and, therefore, more attractive compared to those of other nations. By motivating the global marketplace with greater motivation to buy its goods, China ensures its economic prosperity.
As long as a currency peg keeps the yuan low relative to other currencies, consumers using foreign currencies can buy more of China's exports than they would if the yuan was more expensive. For example, if the People's Bank of China keeps the yuan weak compared to the U.S. dollar, consumers using the greenback can buy more Chinese exports.
Exports are a major driver of any economy because they represent money flowing into a nation. To keep the yuan artificially low and support robust export activity, the People's Bank of China engages in currency purchases. As a result, the central bank’s foreign exchange reserves (minus gold) surged from roughly $600 billion in December 2004 to $3.8 trillion in December 2014.
This currency manipulation has helped China thrive, as the nation's economy has repeatedly experienced robust growth rates of more than 10% over the last decade. China’s industrial sector has done particularly well. According to the Congressional Research Service, the nation became the world's largest manufacturer in 2010. Due to robust growth, China doubled its gross domestic product (GDP) per capita over the course of a decade, a feat that took the industrialized United Kingdom 150 years to complete. This rapid expansion has helped China grab a 25% to 26% share of global value-added manufacturing since 2014, according to U.N. estimates reported by the Congressional Research Service.
Costs and Benefits
While these facts and figures are positive for China, that is not the case for everyone. U.S. manufacturers and workers have complained about the Chinese trade surplus claiming that the yuan peg has granted Chinese companies an unfair advantage. As a result, U.S. lawmakers have called for the revaluing of China's currency.
While opponents of yuan pegging have complained, they may be oversimplifying the situation. An artificially low yuan is not without its benefits. The currency peg means cheap Chinese goods for U.S. consumers, a development that can help keep overall inflation at a modest level. The benefits of less expensive goods extend to businesses. U.S. companies that use less expensive imported items from China to make goods enjoy reduced production costs. With lower expenses, firms can either lower the prices for consumers, increase their profits or both.
Chinese trade deficits also provide a boon to the broader economy as they necessitate the movement of capital to the United States from China. If this foreign capital goes toward purchasing interest-bearing securities, such as U.S. Treasuries, this creates downward pressure on borrowing costs and encourages stronger investments. In addition, lower interest rates support economic growth.
The Bottom Line
Pegging the yuan is a strategic policy move that provides crucial benefits to the Chinese economy. Using this approach, the People's Bank of China increases the appeal of Chinese exports on the global marketplace and helps fuel greater prosperity for China. While many governments harness expansionary policies in the hope that they will generate the intended results, China has proved the efficacy of its currency peg over many years.