China Faces Currency Valuation Crisis

There are two main threats currently facing the Chinese economy, and to the chagrin of the country’s policymakers, the yuan is caught squarely in the middle.

China’s central bankers have long been accused of pursuing a policy deliberately aimed at weakening the yuan to help ensure the competitiveness of China’s exports in the global marketplace. Indeed, it was China’s ability to manufacture and market goods at cheaper rates than most other exporting nations that helped make China the world’s leading exporter.

One unintended side effect of this growth however, has been a rapid increase in domestic consumerism. This is the result of a new wave of wealthy entrepreneurs, together with the rise of a working class armed with an increasing disposable income and a growing desire for consumer goods. It is this conflict – the clash between the needs of the exporters balanced with the need to address the threat of domestic inflation – that is forcing Bank of China officials to reconsider its yuan valuation policy.

China’s main export market in the United States has started to rebound in the past few months. Today’s Non-Farm Payroll report determined that unemployment fell to 9.7 percent from 10.0 percent in January, but it is still far too early to declare things are back to normal. Meanwhile, Europe – China’s second-most important market – is still suffering an on-going debt crisis in several Euro Zone nations, that continues to drag down the value of the euro.

Things are also touchy on the home front however, as a rapid increase in domestic spending has officials warning of the potential for inflation. Much of this spending has been in the form real estate and has propelled property values dramatically in recent months. Prices rose at an annualized rate of 7.8 percent in December on top of a 5.7 percent increase in November, marking the fastest rate of growth in nearly two years.

The dilemma facing policymakers is clear – keep the yuan weak to boost exports or increase rates and buy up excess liquidity in a bid to head off inflation.

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