Currency Wars

Last week in Washington DC the annual meetings of the World Bank and IMF took place. High on the agenda was the appropriate level of exchange rates at which countries should trade in the globalised environment. China has been deliberately keeping its exchange rate low in order to maintain a competitive advantage in its exports. Normally when countries achieve a balance-of-payments surplus their exchange rate appreciates (as more of the their currency is demanded) and thereby encourages imports and enable other countries (western economies) to produce and export more. A way out of this currency protection is if these surplus countries stimulated domestic demand so that export revenue would be less significant in the make up of their GDP. The Chinese delegation in Washington are not against rebalancing their currency but they suggest that this takes time. Time which the west cannot afford.

To give you an indication of how undervalued the Yuan (Chinese currency) is The Economist produced a recent Big Mac index chart – see below.

In China a McDonald’s Big Mac costs just 14.5 yuan on average in Beijing and Shenzhen, the equivalent of $2.18 at market exchange rates. In America the same burger averages $3.71. That makes China’s yuan one of the most undervalued currencies in our Big Mac index, which is based on the idea of purchasing-power parity. This says that a currency’s price should reflect the amount of goods and services it can buy. Since 14.5 yuan can buy as much burger as $3.71, a yuan should be worth $0.26 on the foreign-exchange market. At just $0.15, it is undervalued by about 40%. The tensions caused by currency misalignments prompted Brazil’s finance minister to complain last month that his country was a potential casualty of a “currency war”. The Swiss, who avoid most wars, are in the thick of this one. Their franc is the most expensive currency on our list.

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