Exchange Rate Manipulation-Balance of Payments

1. How does China continuing to undervalue its currency threaten the industrial economies of its largest trading partners?

China undervaluing its currency threatens the industrial economies of its largest trading partners in the following way. To devalue a currency means to simply lower the value of the currency. In other words, it means that other currencies, such as the USD, can purchase a larger quantity of RMB's per unit of USD. By undervaluing the RMB, China's exports become very cheap for global consumers, such as the US. This increases demand for Chinese exports in the global market from countries such as the US. In the US, for example, that would mean that demand for domestic goods would decrease, because they can import those goods from China at a lower price. This harms the domestic market in the US, and may lead to an increase in unemployment within the US.

Definitions:
-Export: a product or service sold abroad
-Unemployment: the number or proportion of unemployed people

The situation described above will be illustrated by figure 1.1 and 1.2:

Figure 1.1

Figure 1.2

Figure 1.1 represents a situation in which the US is not importing calculators from China. The domestic producers produce Q4 at P3 and the US imports Q4Q5 calculators at a price of P3 from the. In figure 1.2 we can see a situation in which the US is importing calculators from China. Since China's currency is undervalued, China is able to export its supply of calculators at a lower price than the rest of the world. In this situation the domestic producers produce Q2 calculators at a price of P2, while Q2Q3 is imported from China at a price of P2. From these graphs we can see exactly how China's cheap exports affect the calculator market in the US. Domestic producers get less revenue, and the domestic market for calculators has gotten smaller, therefore increasing unemployment. This is how it threatens the industrial economies of its larger trading partners.

Definitions:
-Import: bring (goods or services) into a country from abroad for sale.
-Revenue: income, especially when of an organization and of a substantial nature.

2. What is China’s purpose for maintaining the low value of the RMB relative to the currencies of other nations?

China's purpose for maintaining the low value of the RMB relative to the currencies of other nations is as follows. By maintaining a relatively low value of RMB, China's exports will be a lot cheaper than if the value of the RMB was relatively higher compared to currencies of other nations. A cheap RMB allows producers within China to keep production costs low. This makes their exports cheaper, and as such increases demand for them in the global market. Other nations, in this situation, will have higher production costs than China, and will be unable to set their exports at a price lower than that of China. This gives China a competitive advantage in the global market and increases the money entering the country. That is China's purpose for maintaining a low value of RMB relative to other nation's currencies.

3. What would be a unilateral protectionist measure the US government may advocate if the WTO refuses to take action against China’s currency manipulations? How would you advise president Obama on the issue of whether to take protectionist action against China in the context of the current economic crisis in America?

A unilateral protectionist measure the US government may advocate if the WTO refuses to take action against China's currency manipulation can be imposing a tariff on Chinese imports entering the US. A tariff is a tax or duty to be paid on a particular class of imports or exports. In the context of the current economic crisis in America, I would advise Obama to impose a tariff on Chinese imports entering the US to improve the US economy. A tariff on Chinese imports would decrease demand for them in the US, and would grant domestic producers a higher market share. What I mean by that is that they will be able to supply more goods at a higher price, which should help improve unemployment. It should help improve unemployment because if more goods are being produced domestically, through reason we can assume that that would require a larger workforce, therefore creating more jobs in the US. Unemployment and growth was one of the issues mentioned in worksheet 23.1, and due to reasons explained previously, a tariff on Chinese imports entering the US would improve the rate of unemployment, and also growth. It would improve growth because more goods are being produced in the US than before.

This situation can be illustrated with the following graph:

Figure 1.3

Without the tariff domestic producers produced Q1 marshmallows at a price of P1. Q1Q5 was imported from China. With the tariff imposed on China, domestic producers now produce Q2 marshmallows at a price of P2. Q2Q4 is now imported from China at a price of P2. Domestic producers receive a larger market share, which benefits the US in ways mentioned previously. While that may be true, welfare loss does occur represented by the triangles between Q1Q2 and Q4Q5. Freedom is not free.