Question

1. Assume that you are in charge of pegging the RMB to the USD at a RMB1 to $1 rate.

-If China’s production is largely exported to the US, will market forces likely move the RMB’s value to $1.20 or $0.80?

-If China’s economy is largely production based and wants to continue encouraging US firms to purchase its goods, will it conduct a devaluation or revaluation of the USD?

-How will it execute this peg?

-What are two risks of doing this long term?

Answer 1

RMB pegged to US$ at RMB1 to $1 rate.

China's production largely exported to US, the market forces of demand and supply will likely move the RMB's value to $1.20 or $0.8. If there is more demand for Chinese products in USA, this will lead to increase in chinese exports and thus appreciation of Chinese currency and vice versa

Chinese economy will conduct a revaluation of USD to RMB to increase the profits that it will earn as a result of exports.

This peg will be executed by devaluating its currency against dollar.

Risks of doing this in long term

1. Huge currency reserves imply more monetary supply and as a result inflation may occur.
2. currency pegs can allow a huge difference to arise in the fundamental value of a currency and its market value and thus a risk of speculative attacks