Friday, January 8, 2010


Foreign Inflows in China (dollars, euro) --> Demand for yuan rises which will lead to strengthening of yuan (China doesn’t want that as it hurts their EXPORT industry) --> China’s central government prints huge amount of yuan to buy the foreign exchange --> China’s government makes its bank to keep large amount of yuan to lend more and buy the foreign exchange --> this excessive lending and flow of yuan in the market increases the scope of INFLATION (which no government wants) --> Here is where China play its master stoke --> to control inflation and strengthening of yuan, the central bank sells its bills mainly to banks, which pay in yuan that the central bank then effectively takes out of circulation, slowing growth in the country’s money supply. This process sucks out liquidity from market in turn taming the inflation and keeping the yuan weak --> but to play this game they have to buy $300 billion of foreign currency every year leading its foreign exchange reserves exposed to currency fluctuation, this is what they are trying to restrict by diversifying towards other assets such as GOLD. --> The biggest benefit they are getting is keeping there export going and keeping there people employed in turn raising the unemployment rate of other country (look at US and UK, both countries have unemployment rate of 10%. US have virtually shifted all there manufacturing base to CHINA).
Dollar has depreciated against all major currency except yuan (against some currency it has made yearly low for example Yen). Many central goverment including US have raised there concern about China's policies. This policy have made export from these countries including India less lucrative, thus impacting there export industry.
But why can't other goverment apply the same policy as China. The likely answer are:
1. China despite its economic expansion, is a puzzel many still trying to solve. The economic policies it follow is difficult to replicate in other countries.
2. It's currency is not free floating as it does not want its currency to rise. Other countries do allow their currency to free float, India follows partial covertible rule. Many economist have recently said that China should allow its currency to appreciate.

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