Why China’s Currency Tangos With The USD

It takes two to tango, but unless both partners move in perfect cohesion, a sequence of graceful maneuvers can be reduced to a series of clumsy moves. The latter depiction seems to be particularly apt when it comes to explaining the gyrations between the Chinese yuan and the U.S. dollar, thanks to China’s recalcitrance on the topic of yuan appreciation and the United States’ reluctance to be a partner in this currency tango.

A great deal is at stake here. The contentious issue of yuan revaluation has implications not just for the world’s two largest economies and the global economy, but also for your personal well-being through its potential impact on your expenses, investments and perhaps even job prospects.

An Economic Miracle

China commenced its transition to a global powerhouse in 1978, as Deng Xiaoping ushered in sweeping economic reforms. In the three decades from 1980 to 2010, China achieved GDP growth averaging 10%, in the process lifting half of its 1.3 billion population out of poverty. The Chinese economy grew five-fold in dollar terms from 2003 to 2013, and at $9.2 trillion, it was easily the world’s second-largest economy at the end of that period.

But despite a slowing growth trajectory that saw the economy expand by “only” 7.7% in 2013, China appears to be on track to surpass the United States as the world’s largest economy sometime in the 2020s. In fact, based on purchasing power parity – which adjusts for differences in currency rates – China may pull ahead of the U.S. as early as 2016, according to a report on global long-term growth prospects released by the Organization for Economic Cooperation and Development in November 2012. (It should be noted that such bullish estimates about China’s long-term growth prospects are viewed with considerable skepticism by a growing number of economists and market watchers.)

China’s rapid growth since the 1980s has been fueled by massive exports. A significant chunk of these exports goes to the U.S., which overtook the European Union as China’s largest export market in 2012. China, in turn, was the United States’ second-largest trading partner in 2013, its third-largest export market, and by far its biggest source of imports. The tremendous expansion in economic ties between the U.S. and China – which accelerated with China’s entry into the World Trade Organization in 2001 – is evident in the more than 100-fold increase in total trade between the two nations, from $5 billion in 1981 to $559 billion in 2013.

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