Could China favor a free float Yuan to end dangerous speculation?

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Photo Source: Yale Global

After a decade long peg of 8.3 Yuan to one US dollar, China may institute either another absolute peg or a free float currency in order to take out the speculators that it blames for high inflation and other economic concerns. Since shifting from a complete peg to a peg against a “basket of currencies,” the Chinese Yuan has appreciated at a rate of over 21 percent since the peg was lifted.

Natural and unnatural Chinese inflationary factors

For much of the last year, China has suffered from inflation caused by a large trade surplus (natural) and speculation in its currency markets (unnatural). The impacts of the currency speculation are just becoming clear as the Chinese government plans a new offensive to crack down on speculative money that is making its way into the country in the form of inflated service deals. China now sits on nearly $1.7 Trillion worth of foreign currency reserves that are feeding the fire of inflation. In order to keep domestic inflation low, the government will have to work to remove cash from circulation and prevent the speculators from flooding the country with even more cash.

Two ways to curb China’s inflation

There are two solutions for the Chinese government. Either the currency could be allowed to free float and probably gain another 10-20% in value in just a few weeks, or the Yuan could be again pegged to the dollar to keep up the trade surplus with the United States while keeping the value low. A low priced Yuan is what the Chinese want in order to dominate the pricing of the goods bought and sold around the world. Simply put, cheap products means more manufacturing orders from China.

But the new debacle might bring another look into the fair market float of the Chinese Yuan in order to curb speculation. After the initial movement, it could be expected that the Yuan would trade in a fairly tight trading range, though probably gaining value over time – which is something that the government does not particularly want. If the market were allowed to set the price for the currency, many economists and traders believe that another large correction in the double digits would finally set the record straight. The Yuan has been severely undervalued for far too long.

The difficult solution

The only way to moderate the effects of the growing speculative investment would to be examine the books of many different corporations that all vend different products. As of today, most of the speculative money that enters China makes its way via the service industry. Monitoring all of the data to find entries of money might prove so complicated that China instead goes back to a freefloating currency. One can only hope…

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