Exchange Rates between U.S. and China Management Essay

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Exchange Rates between U.S. and China
Introduction
Exchange rates play a major role in international trade. According to Kang and Dagli, exchange rates impact trade and as a result, many countries strive to implement effective exchange rate policies to secure a strong position in international trade (84). Also, effective exchange rate policies enhance the stability of the domestic economy. The exchange rates are one of the major factors affecting the trade and exchange relations between the U.S. and China. This paper examines the effect of exchange rates on multinational corporations, the balance of payments, the balance of trade in the U.S. and China, and their overall effect on the trade relations between the two countries.
Effects of Exchange Rates on Multinational Corporations
Assessing the effect of exchange rates on multinational companies with operations in the U.S. and China is crucial. The exchange rate of any country affects its external competitiveness (Bostan, Toderascu, and Firtescu), which enhances the performance of multinational companies in the country. Also, fluctuations in exchange rates affect the demand and selling prices of products supplied by multinational companies (Chen, Lee, and Huang, 132). This is because the fluctuations affect the cash flow of the corporations through the three components of exchange risks namely; the economic, transaction, and translation exposure. The U.S. and China have some of the largest multinational companies and therefore, their policies on exchange rates are fundamental in the performance of these companies. Over the recent past, China has been termed as a currency manipulator in its efforts to gain a competitive advantage in international trade. This has affected U.S. multinationals. According to Chen, Lee, and Huang, the devaluation of Chinese currency often stimulates exports and consequently “affects the value of multinational corporations in the United States” (133). Also, a devalued currency makes exports cheaper and imports more expensive. Thus, China’s devalued currency, in this case, benefits U.S. multinational, exporting firms with operations in China. In addition, multinational, exporting companies experience a negative exchange rate exposure when the Chinese currency depreciates and the U.S. currency appreciates (Chen, Lee, and Huang, 136). This negative exposure causes a decrease in the value of the multinational companies.
Effects of Exchange Rates on Balance of Payments in U.S. and China
To better understand how the exchange rate affects trade in the U.S. and China, we need to examine the balance of payments in both countries. According to Ribeiro, McCombie, and Lima, if there exists a real exchange rate misalignment, the effect would be felt most on the balance of payments as such misalignments are likely to cause a crisis in the balance of payments (2). The balance of payments accounts for the difference between the inflow of foreign exchange and the outflow of foreign exchange (Shafi, Hua and Satti, 183). Countries use different exchange rate policies, which also have different effects on their balance of payments. Some countries devalue their currency and others use a dual exchange rate system. The latter is more preferred when a country’s balance of payments is weak because they tend to improve the balance of trades and ultimately, the balance of payments (Shafi, Hua, and Satti, 183). While examining the balance of payments, three components are considered. These are the current account balance, the financial account balance, and the capital account balance. An improvement in one or all of the account balances improves the overall balance of payments.
Under this section, the U.S. and China’s balance of payments in the year 2019 will be examined. Specifically, the current account and the financial accounts will be examined based on the data provided by both countries for the second quarter of 2019. The current account comprises of exports and imports of both goods and services. In the second quarter of 2019, the U.S. had a current account balance deficit of $128.2 billion and a financial account balance of -$155.1 billion (Bureau of Economic Analysis). China, on the other hand, had a current account balance surplus of US$ 46.2 billion and a financial account balance surplus of US$ 13.8 billion (State Administration of Foreign Exchange). The tables below present the data for the same period.
Table 1: United States’ Balance of Payments, Second Quarter, 2019
Source: Bureau of Economic Analysis
Table 2: China’s Balance of Payment, Second Quarter, 2019
Source: State Administration of Foreign Exchange
From the statistics above, it is evident that China’s balance of payments is healthy in comparison to their U.S. counterparts. These healthy balance of payments have been attributed to China’s exchange policy. China gave up the appreciation of its currency against the US dollar (Setser). Also, China selectively opened up its inflows as part of its efforts to preserve foreign exchange. The healthy balance of payments has also been a cause of concern for the U.S., who believe that China’s exchange rate policy is unfair. It has been pointed out that China needs to assess its exchange rate and currency policy so that it can play fairly in the market. According to Liu and Woo (6), the surplus balance of payments in China indicates that China has been undervaluing its currency by keeping it from reaching the equilibrium exchange rate. The equilibrium exchange rate is the market-clearing value or exchange rate where the supply of a commodity or service is equal to its demand. The table below shows China’s exchange rates and two components of the balance of payments (current and capital accounts), from 2000 to 2017.
Table 3: China;’s Exchange Rates and Balance of Payments, 2000-2017
Source: (Liu and Woo, 6)
From the table, it is evident that as China’s exchange rate strengthened against the U.S. dollar from 8.3 in 2000 to 6.1 in 2014, so did its current account, moving from 1.69 to 2.25within the same period. However, the balance of payments remained in surplus throughout this period, an indication that China kept its currency from reaching the equilibrium value, as posited earlier.
Effects of China’s Exchange Rates Policies on U.S. Trade balance
China’s exchange rate has been linked to U.S. deficits i...