Pegging its currency to the US dollar had been China’s foreign exchange rate policy since the onset of its economic development. As the Chinese economy becomes stronger, there were calls for the Chinese monetary authority to float the rates. It is very likely that, if the Chinese Central Bank floats its exchange rate, its currency would be valued higher than it is now, and that its exports would not be as cheap, lowering demand for its goods globally, and perhaps encourage demand of goods from other countries. It could have a dampen effect on the red hot Chinese economic growth.
At the same time, as China is one of the largest creditors of the US, it does not want the rate to change. Upward float of its exchange rate with the US Dollar would mean less value in its debt holding. A almost fixed exchange rate would allow the Chinese financial sector to know exactly the value of the debt they are holding, rather than fluctuations that could spur risk taking and speculations. So its currency remains pegged to the dollar, unlike the currency of the rest of the countries in the world.
As the Chinese economy develops, however, its currency will strengthen and the pressure would to change its rates could be become greater over time. It is very likely and possible that at some point, the pressure would be great enough for the Chinese currency to appreciate, as China is developing at a much faster rate in terms of GDP growth than the US. But what if the rates change? The value of its holding of American bonds would certainly be much less than what it paid for. How should the Chinese government react?
Frankly, China should not be upset if its holding of US debt loses some value, if it does. It should not be upset that its currency could be stronger now than it was when it purchased debt holdings from the US. Politically, what had been the most important in Chinese modern politics had been the concern for “stability”. The government had slowed human right developments, cracked down on dissidents, regulated birth, all for the sake of stability. Pegging its currency to the USD also has the stabilizing effect. In fact, it is by fixing the rates that it gives itself a relatively stable environment to nurture the economic growth on a global scale. And in achieving this stability, losing the values of its foreign debt holdings as a consequence of this is a small price to pay in comparison.
Or, you can say that the Chinese currency should be allowed to appreciate, in which case the Chinese government then pays for the “stability” that it desires with losing the values on its foreign debt holding. At the end, the government should still be happy as it values stability more than the dollar values that it loses in foreign debt. The US government should press the Chinese government to unpeg the currency, even if for a short term, to avoid distortions in the money market.
At the present, at a point in time where the demand for US good is artificially lowered due to cheaper exports from China, and the unemployment in the US is high, this is important in getting the consumer demand to flow back to US goods and away from the cheap Chinese factories. It is not only necessary, but fair, and important for avoiding a larger, more painful correction later. It is only right thing to do.
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