04 October 2010

International Competitiveness And Exchange Rates

Some economists believe that fiscal stimulus as a panacea for recession is not effective in the best of circumstances, and is wrong for what ails the West now.

They reason that most of the stimulus money injected by Western governments ends up benefiting the emerging economies because the Western economies are not competitive.

In the global marketplace for goods and services, however, competitiveness is a function of both the domestic price of the good or service and foreign exchange rates.

Thus, many people in the US are convinced that the competitiveness of American goods and services vis-à-vis Chinese goods and services is undermined because the Chinese yuan is undervalued by up to 40 per cent against the US dollar.

Similarly, Japanese exporters face tremendous difficulties as the Japanese yen appreciates against almost all other currencies (including the US dollar).  They wish that their government will bring about a cheaper yen to help them.

With China being the world's largest exporter and the second largest economy, an undervalued yuan has adverse implications for the health of the economies of its trading partners and their (the trading partners') ability to enough create jobs for their people.

When a currency is undervalued, the impact on its trading partners is a function of the extent to which the currency is undervalued, and the period over which such undervaluation has occurred.

China says that a significant increase in the value of the yuan will result in many Chinese companies filing for bankruptcy and in severe job losses.  Interestingly, this is the flip side of the coin of what the US has been saying — that the undervalued yuan is hindering economic recovery and job creation in the US.

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