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There are economic links among countries that have to be accounted for when examining the effects of changes in exchange rates. Scholars such as Fair used a Multi-County (MC) econometric model to estimate the effects of Yuan appreciation on the Chinese economy reported the following effects: First, the Yuan appreciation leads to a decrease in China’s import prices which leads to a decline in Chinese domestic prices. The decline in the Chinese domestic prices and the decrease in the world price of exports in Yuan (due to appreciation) lead to a decrease in Chinese export prices in Yuan. Second, the increase in dollar price of Chinese exports relative to the dollar price of other countries’ exports leads to a decline in the demand for Chinese exports. The decline in exports negatively affects China’s GDP which consequently negatively affects the total Chinese imports. Ma and Lu point out that the RMB appreciation on the Chinese economy is modest. For example, if the Yuan appreciated at 3% against the USD per year, it reduces GDP growth by 0.2% and export volume by 0.7%. Moreover, RMB appreciation has a negative effect on sectors such as shipping, electronic components and computers. However, the Yuan appreciation has long-term positive for consumption. For instance, it is expected that the Yuan appreciation will boost consumption by 6.5% (cumulatively) and reduce exports by 11% (cumulatively) within the next five years.
Fair indicates that the effect of Yuan appreciation on other economies particularly the U.S. are as follows: first, the U.S. import prices are high due to higher prices of Chinese imports which lead to an increase in the U.S. domestic prices. This leads to an increase in the price of U.S. exports. A decrease in real wealth and real disposable income are led by the increase in the U.S. price level. For example, according to the U.S. estimated interest rate rule, the interest rate responds positively to an increase in inflation and negatively to a fall in output (GDP). Accordingly, the U.S GDP is affected negatively and positively.
Many economists and politicians perceive that the Yuan appreciation against the dollar would result in reducing China’s trade surplus and U.S. trade deficit. However, scholars such as McKinnon argue that China’s trade surplus is only a reflection of its net surplus of saving over investment and vice versa for the saving-deficient in the U.S. The Yuan appreciation would reduce corporate profitability and some corporate saving but there is no presumption that saving over investment would move if the Yuan is appreciated. Investment in China would sharply fall if it is seen to be more expensive country in which to install productive capacity and produce from it. Because China currently has high investment to GDP ratio (around 40% to 45%), it has a long way to fall and with the greater sensitivity of investment to the exchange rate system, the presumption would be that China’s trade (net saving surplus) would increase with the Yuan appreciation.
The decline in the probability of trade imbalance between China and the U.S. because of China’s currency appreciation should help lift market sentiment for risky asset classes in the short term. After the PBC announcement, investors will expect a modestly positive reaction from the Chinese equity markets (e.g. airlines), because of investors’ expectations of a strong Yuan appreciation. However, it is arguable that the foreign exchange market and allow the “market” to decide what the rate should be when at the same time it has a huge net saving (trade) surplus.