Question

5.           For the purposes of this question, you should assume that China keeps a fixed exchange rate with the US. Answer the following questions.

a.           How does China’s fixed exchange rate contribute to its current account surplus?

b.           How is China’s fixed exchange rate policy related to its exceptionally large holdings of dollar denominated assets?

c.           Suppose the Chinese decide to float. Is it inevitable that the Chinese will appreciate given their higher rate of growth as compared to the US?

Answer 1

Solution A

Chinas fixed exchange rate allows China to keep exporting without an appreciation or depreciation and hence China will devlaue its goods making it ezports attractive in world and US. Hence exports will increase than imports for China and Hence Current account Surplus will increase .

Solution B

Fixed exchange rate allows China to devalue its goods and export to larger scales to UsA. Hence majority of forex reserves are dollar denominated because dollar is baskrt currency and Us is major importer of Chinese products which allow China to Have more Dollar Denominated assets.

Solution C

If chinese currency is allowed to float then this will largely make currency appreciate and hence current account surplus of China will decrease and so will trade deficit of US.