Us-China Exchange Rate

Topics: Foreign exchange market, Bretton Woods system, International trade Pages: 21 (7071 words) Published: November 21, 2010

The objective of the report is to analyze the trade relationship between US and China as the issue regarding US blaming China’s undervalued currency arise due to US which incur trade deficit. In addition, the report would like to examine the factors that lead into the US-China trading problems.

Therefore, first section in the report discusses the background of US-China trading. The next section explains the dynamics of exchange rate mechanism works and how it set upon. Then, fourth section elaborates the factors that lead to distortions in trade between two countries due to unfair trade. The fifth section clarifies about China’s exchange rate policy and its impact on the global financial and economic market while subsequent section analyze about the factors behind the trade deficit with China. Lastly, the section examines the measures that can be taken by international financial bodies in ensuring the exchange rate mechanism works.


US-China trade rose rapidly after the two nations established diplomatic relations in January 1979, signed a bilateral trade agreement on July 1979, and provided mutual most favoured-nation (MFN) treatment beginning in 1980. Total trade (exports plus imports) between the two nations rose from about $5 billion in 1980 to $366 billion in 2009 (Table 1); China is now the third-largest US trading partner. Over the past few years, US trade with China has grown at a faster pace than that of any other major US trading partner (Morrison, W.M., 2005). Throughout the years, even their trading keep continuing, both countries faced difficulties in managing their trading relations. Therefore, it is crucial to analyze how the exchange rate mechanism influenced US-China trading as they involve foreign market.


The above table describe the relationship between China and US trading. As we can see, the total of US exports and imports are keep increasing with there is significant changes in US imports. 3.0 EXCHANGE RATE MECHANISM

Exchange rate is defined as a rate at which one currency can be exchanged into another currency. In other words, it is a value of one currency in terms of other when the countries involves in foreign exchange market. The exchange rate mechanism (ERM) is a methodology to determine the currency exchange rates within an agreed-upon range with respect to other countries. The entire world’s economic system depends on the exchange rate. It is very important because it determine the competitive advantage among businesses globally. For example, if China can buy the same product from Germany that it can from the US, thus China more likely will buy from Germany and then US will lost their competitive advantage. Or else, regarding a travel to other country, the travellers should think about the exchange rate as a means to have reasonable vacation.

The mechanism itself is market forces which determine the foreign exchange rate. On the ground that banks do most of actual trading through over-the-counter market, it purpose is to satisfying its currency needs. For example, foreign exchange (Forex) trader trades with broker and then broker trades with banks or else, businesses directly communicate with banks for exchanging the currency. There are a lot of factors influencing the exchange rate. However, the basis is about supply and demand for the currency. In order to indicate how dynamic the ER mechanism works, the Figure 1 summarising its flows towards the determination of ER, taken Renmimbi Yuan (RMB) as an example (Spaulding, W.C., 2005-2008). According to Figure 1, the main currency of China is the RMB and as an international bank, the bank also deals with other currencies in Forex market. By taking the US dollars as an example for exchanging the currency, some customers will want to exchange Yuan for dollars, and some will want dollars for Yuan. Since an international bank...
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