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Inflation, interest rates, income level, government tariffs

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Question B3
 
“U.S.-China economic ties have expanded substantially since China began reforming its economy and liberalizing its trade regime in the late 1970s. Total U.S.-China merchandise trade rose from $2 billion in 1979 (when China’s economic reforms
began) to $636 billion in 2017. China is currently the United States’ largest merchandise trading partner, its third-largest export market, and its biggest source of imports. In 2015, sales by U.S. foreign affiliates in China totaled $482 billion. Many U.S. firms view participation in China’s market as critical to their global competitiveness. U.S. imports of lower-cost goods from China greatly benefit U.S. consumers. U.S. firms that use China as the final point of assembly for their products, or use Chinese-made inputs for production in the United States, are able to lower costs. China is also the largest foreign holder of U.S. Treasury securities (at $1.2 trillion as of April 2018). China’s purchases of U.S. debt securities help keep U.S. interest rates low… More recently, the Chinese government has diversified its investments in order to obtain higher returns, such as by encouraging its firms (especially SOEs) to invest overseas to become more globally competitive, as well as to help China gain access to raw materials (such as oil), food, and technology. As a result, Chinese annual FDI outflows have grown significantly in recent years, rising from $21 billion in 2006 to $183 billion in 2016, making China the second-largest source of annual global FDI outflows.”1(W. M. Morrison, 2018)
 
As you work for a U.S. company that exports goods to China, you are expected to forecast the value of U.S. dollars with respect to the Chinese yuan.
 
Required: Explain how each of the following conditions will affect the demand and supply of the currencies, hence affect the value of the dollar against Chinese yuan, holding other things equal.
 

  1. a) While U.S.’s inflation remains low, Chinese inflation increased substantially. (4 marks)

 
 

  1. b) Chinese interest rates have increased substantially, while U.S.’s interest rates remain low. Both countries’ investors are attracted to high interest rates. (4 marks)

 
1 Wayne M. Morrison, “China-U.S. Trade Issues”, Congressional Research Service, July 2018

  1. c) With the economic growth, the income level increased substantially in China while U.S.’s income level has remained comparatively stable. (4 marks)

 
 

  1. d) The U.S. government is going to increase the tariff on goods imported from China. As a result, Chinese government will also increase the tariff on goods imported from the U.S. (6 marks)

 
 

  1. e) Based on the reported figures of trade and investments between the US and China, combine all expected impacts mentioned from Question (a) to (d) to develop an overall forecast of the dollar’s movement against the Chinese yuan. (10 marks)

 
Total 28 marks
 

 
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