Currency

Will A Stronger Yuan Slow Down China?

All eyes are on the yuan today following China's weekend announcement that it will let its currency appreciate against the dollar. By midday on Monday, the Chinese currency had risen to its highest level against the dollar since 2005.

This weekend's news has sent stock markets here in the US and Europe soaring. U.S. manufacturers and exporters are feeling especially confident, as a stronger yuan will make it easier for them to compete in China.

But what will the currency appreciation mean for China — a country that has seen astounding growth in the last decade? Some fear that a quickly rising yuan could send China down the same path of slow growth that Japan faced during the late 1980's, when it let the yen rapidly strengthen against the dollar.

A new paper from two economic professors at the University of California, Berkeley, Barry Eichengreen and Andrew Rose, suggests China may not have much to fear.

In the paper, "27 Up: The Implications for China of Abandoning its Dollar Peg," Eichengreen and Rose analyze economic growth in 27 places where "a fixed peg was abandoned and the currency appreciated over the subsequent year either against the dollar or the SDR." Here are some of their findings:

The average annual rate of GDP growth slows by 1 percentage point between the five years preceding the exit and the five years following. But, there is no growth collapse. Exiting up does not doom the economy to a Japanese-style lost decade.

More generally, we find little evidence of economic and financial damage as a result of exits up.

  • There is no increase in the incidence of banking and financial crises.

  • There is no evidence of significant stock market declines.

  • There is no evidence of a significant deterioration in the current account.

  • There is no evidence of a significant fall in the investment rate.

     

The bottom line: Chinese growth may slow, but their economy is unlikely to nosedive.

To hear more about China's currency policy, listen to our podcast: Did China's Central Bank Take Your Job?

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