Optimal Currency Areas: Understanding Exchange Rates & Output Fluctuations - Essay Sample

Introduction

The relation between the output vitality and the exchange rate lies between the channels of international finance on the optimal currency areas (Ay, Ozsahin & Gerceker, 2014). Understanding the exchange rates requires the knowledge of the floating exchange rates and the ability to adjust the external shocks to fix the nominal shocks. According to Brazdik (2013), the decision of the exchange rate regime affects the nominal variable, such as the relative prices and inflation to finance and exchange rate stability. China is one country that was very unstable with the exchange rate (Mackinnon, 2013). The paper will, therefore, outline the history of China's exchange rate to the present and the policy put in place to stabilize.

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Research conducted by Zhang & Liang (2016) discovered that the china exchange regime history is quite interesting because of the changes made to determine the stability of the economy. Since 1949, china has diverted from a fixed exchange rate to a floating exchange rate. Several issues occurred due to the influence of international trade (Mccarthy, 2014). Even though the country failed to manipulate its currency, the U.S. has always assisted china in evaluating their money (Liebscher, 2014). As a result, the state decided to assess its currency so that the exports can be attractive enough to sustain their consumption. In this next section, a brief history of the country's exchange rate will be elaborated to understand what their goals were and the policies they used.

The policy of intervening in China's currency markets was embraced to control the renminbi (RMB) and currency against the U.S. dollar (Shen, 2013). The idea is to manipulate the currency of the nation of China to contribute to the merchandise trade deficit and the decline on manufacturing jobs in the U.S. several people argued that the undervalued currency in China was a contributor to the annual merchandise trade deficit. However, Edelberg (2018) added that due to this, the Federal Register proposed to make the undervalued currency to subside under America's countervailing policies.

Ever since the value of RMB went against the U.S. dollar, the economists contended that its decline was caused by the slow economic growth of China (Wu, 2018). The country eventually pegged the RMB for several years against the dollar because the buy and sale needed to attain a specific target. Due to this pressure for partners in the trade like the U.S, they appreciated the RMB because of the global effects such as economic crisis on its export and the dollar. Cui (2013), added that after a few years, the RMB began to fall due to the 2008 economic slowdown when the government was trying to rebalance the imports and exports of the country.

The History of China's Exchange Regime

China's exchange rate regime began since the 1949 revolution, facilitated by the communist party due to the priorities of economic policy (Liang, 2006). The transition that took place towards the market mechanism led by the party leaders opened up the Chinese economy, and interacted international trade. By 2005 china joined the world trade organization to make its dedication towards agreeing on the neoliberal economic policies (Sutherland, 2015). Moreover, the nation also increased the interaction of goods in international market to observe if their currency will be manipulated towards the international trade. Therefore at this time, china changed its shift and used the floating exchange rate to allow the demand and supply of forces in the market to avoid fluctuations that took place for certain brands (Sutherland, 2015). This shift also undervalued china's currency that arose due to contemporary changes caused by the U.S. dollar.

The Rationale Behind China's Floating Exchange Regime Rates

The exchange rate of China was developed due to the fear of floating. The renminbi was under the appreciation pressure made the authorities to fear depreciation. As a result, the renminbi was always undervalued, and this became conducive to China's economic growth to drive the misallocation of resources (Mussa, 2012). The country's economic growth was affected to the point where it accumulated four trillion dollars of foreign exchange reserves. As the devaluation pressure arose, the stability of the currency forced the unwinding facilities and money to facilitate. Within two years, the foreign exchange reserves in China fell by one million trillion. The People's Bank of China also tried to make the renminbi flexible, but it failed. In 2015, the renminbi began again, and this time, they took appropriate steps to unshackle the RMB exchange rate (Yiu & Cheung, 2016). As a result, China managed to use the floating exchange rate.

The Benefits of the Floating Exchange Rate

One of the advantages of international currency is the trade that takes place between the associated losses and the benefits that arise for the externalities (Lothian & Mccarthy, 2014). The internationalization of RMB, especially if it becomes international currency, is that it benefits the people of China. One benefit of the RMB in china is that it acts as an invoicing and settlement currency by reducing the exchange risks of international investment and trade to reduce the transaction cost (Aizenman, 2015). The description is theoretical because such an exchange rate reduced the transaction cost and rate risks to create the monetary integrate and efficiency into the world economy.

The internalization of china's exchange rate was helpful because it reduced the currency mismatch for many financial organizations (Zhang, 2011). The RMB alleviated the challenge of 'original sin' that made the emerging economies struggle (Lothian & Mccarthy, 2014). Moreover, the exchange rate denominated the financial institutions by reducing the effects and risks of the foreign exchange for international settlements as required by the capital adequacy.

Disadvantages

A research done by the Bank of International settlement noticed that the RMB exchange rates is less than one percent of the daily turnover in the global currency market (Liu & Zhang, 2019). The Swift reports released in 2011 also added that the usage of the RMB was under 0.3 percent of the world's payments. However, the overall value of the currency was 0.8 percent in the capitalization of China (Zuojun & Xiaoqin, 2011). Given the ability to liquidize the financial markets and complete the internationalization of the floating exchange rate, the regime does not have a realistic outcome for China's future.

The domestic financial market is at the initial stage that makes the capital account control, thus restricting the RMB to circulate freely (Lombardi & Malkin, 2017). A more robust domestic bond is also needed before the RMB to be used for the global markets and interest rates across the market forces. In other words, the floating exchange rate holds back the international reserve currency. According to Basu (2015), China's currency of China, in other words, which is under the political democracy lacks transparency as the country discouraged foreign investors from having large amounts of RMB to articulate the reserves?

The Success of China's Floating Exchange Rate Regime

The debate on the exchange rate regimes adopted by China for the last six decades has proved that the policies adopted and modified the national systems in the country. The national interest and early command economy of the Maoist economy promoted China's policy (Bonnin & Cartier, 2019). The fixed overvalued exchange supported China's goal to import more attractive and cheap raw materials to support the industrialization goals. According to Lucas (2014), the Deng transition economy, on the other hand, that consisted of the dual exchange rate system adopted the exchange rates that work under the fixed regime even though the promoted exports were undervalued.

The reconnaissance also promoted economic growth through the promotion of exports to control the exchange rate that assured that the industrialization goals were fulfilled (Deng, Ma & Shao, 2014). As a result, the two created an undervalued exchange rate that emphasized the compliance of the neoliberal economic principles. Even though China's current effort to allow the market mechanism to determine the floating exchange rate, the nominal exchange rate equalized the real value of the exchange rate (Steinberg, 2015). The results were that the undervalued currency allowed China to control global trade.

Conclusion

China is one country that has changed its exchange rate due to its unstable economy. Even though the country had a fixed exchange rate, the losses it incurred made the government dissolve the policy. The essay also elaborates that even though the floating exchange rate regime has helped China boost its economy, it also has an adverse effect. However, the RMB, in other words, protects China's economy.

References

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