Forex Blog: Currency Trading News & Analysis.

June 28th 2005

Is the Yuan really undervalued?

Investors and economists have been betting on the Chinese Yuan’s revaluation for several years now.  Economists estimate the Yuan is undervalued by 40%.  Congress has adopted the average of 15% and 40% estimates, in calling for a 27.5% across-the-board tariff on Chinese imports.  The Economist’s Big Mac Index indicates the Yuan is 59% undervalued. Who is correct?

There are several viable methods economists use to value currencies. First, the theory of Purchasing Power Parity dictates prices in different countries should converge, to offset divergent exchange rates. An application of this theory to China indicates the Yuan is undervalued by 40%. Next, a nation’s ‘fundamental equilibrium exchange rate’ can be calculated, predicated on current account and trade balances. In this case, while China runs an enormous trade surplus with the US, it runs trade deficits with several other countries. As a result, economists using this method reckon the Yuan is only undervalued by 15-25%. Finally, economists constructing estimates base on the ‘behavioral equilibrium exchange rate’ method use economic indicators, such as inflation and employment statistics, to calculate the fair exchange rate. Such methods produce exchange rates which are only 7% below current rates. As a result, much of the uproar over China’s refusal to revalue may not be predicated on solid economic logic. The Economist reports:

The uncertainty about fair value explains why the IMF and America’s Treasury prefer to say that the yuan needs to become more “flexible” than to call for revaluation outright…calls for a revaluation of 27.5% rest on flimsy foundations.

Read More: Precisely Wrong

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Posted by Adam Kritzer | in Chinese Yuan (RMB), Investing & Trading | No Comments »

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© 2004 - 2018 Forex Blog.org. Currency charts © their sources. While we aim to analyze and try to forceast the forex markets, none of what we publish should be taken as personalized investment advice. Forex exchange rates depend on many factors like monetary policy, currency inflation, and geo-political risks that may not be forseen. Forex trading & investing involves a significant risk of loss.