Reference no: EM13207922

"Should China be forced to alter the value of its currency?"

The United States and the European Union members are pressuring the Chinese government to float its currency, yuan. As you are well aware the United States is suffering from a large and growing trade deficit with China. Our domestic firms which produce the same products that are imported from China are unable to compete with them. Chinese companies, due to low labor costs, have a huge competitive advantage over the American firms. Our Exporting firms, due to low value of yuan, are also at competitive disadvantage. Leaders of both political parties and some business interests (manufacturing sector) in the United States have put pressure on the past and current U.S. Administrations to force the Chinese to revaluate their currency so that American firms can compete with their Chinese counter part. On the other hand, business interest lobbying for the American companies (such as WalMart) arguing such a change in yuan value will result in higher prices for imported goods. As a result American consumers shopping in those stores will end up paying higher prices, which ultimately will result in higher inflation rate in the United States.

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Some U.S. politicians want to pressure China to increase the value of the Chinese yuan, which until recently has been tied to the U.S. dollar. They claim that the yuan is the cause of the large U.S. trade deficit with China. This issue is periodically raised not only with currencies tied to the dollar, but also with currencies that have a floating rate. Some critics argue that the exchange rate can be used as a form of trade protectionism. That is a country can discourage or prevent imports and encourage exports by keeping the value of its currency artificially low.

China might counter that its large balance of trade surplus with the United States has been due to the difference in prices between the two countries and that it should not be blamed for the high U.S. prices. It might argue that the U.S. trade deficit can be partially attributed to the very high prices in the United States, which are necessary to cover the excessive compensation for executives and other employees at U.S. firms. The high prices in the United States encourage firms and consumers to purchase goods from China. Even if China's yuan is revalued upward, this does not necessary means that U.S. firms and consumers will purchase U.S. products. They may shift their purchases from China to Indonesia or other low-wage countries rather than buy more U.S. products. Thus, the underlying dilemma is not China, but any country that has lower costs of production than the United States.