MGT 660 International Business, University Of Management And Technology, USA
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Question 1: Describe how free trade works (ideally). In the discussion, be sure to address barriers to free trade associated with protectionist policies. (1-2 pages, single spaced)
Answer: Free trade and Barriers
Free trade is highly controversial in terms of the merits and demerits. There are diverse opinions exists in the scholarly literature about the merits and demerits of free trade in general. Also the consequences and the advantages of free trade do depend on the socio-economic structures prevailing in the society as well. During 19th century, England and other colonial powers of the globe employed principles of the mercantilism, where in the raw materials were procured from different colonies spread across the world and they employed their industrial capabilities to convert these raw materials into the finished goods and done marketing of these goods in their colonies with monopoly. Even that time, there were opinions expressed in the free trade debate to open the gates of the business for the parties having comparative advantages. When countries are involved in producing goods in the domains where they have comparative advantage, the global output is believed to improve drastically. However nations believed that such free trade will create hurdles to the interests of their national industries. Global economic crisis of 1920 and 1930 paved way to create protectionist policies which worked on to cater to the interests of the local companies. Smoot-Hawley tariffs in United States is one such evolution formed to protect the interests of the local industries. There is a wide spread belief that the Smoot-Hawley tariff is responsible for the formation of the global depression. As a whole a key focus on the nation's tariff policies and the related governing policies are mainly responsible deciding the free trade success rate (Hornok & Koren, 2015).
Ideally free trade is a system that will not include any type of barriers that can have capacity to distort the normal pricing and goods availability in accordance with the principles of the supply and demand statistics. In free trade environment, nations will not impose any type of tariffs and taxes for sake of letting imports from other countries into their own market. Free trade will not let any type of internal monopolies as well to constrain international producers to do business in their countries. If it is operating fairly, local buyers will set the price by selecting their own options of buying by choosing the right seller from the domestic as well as from international seller options available there in the country. In ideally cases of free trade, countries involved in free trade option will not just share the goods and services, but they will also share the principles of the labor management. All these countries will share uniform labor regulations like respecting human rights in the work place. All countries participating in the ideal labor trade will follow the same principles of the environmental respect and they do follow similar and ideal industrial production policies to safe guard the interests of human rights and the environmental respect and regulations. All these norms in turn will works on for not to let any unfair advantage to one such country at the cost of the breach of the human rights or by environmental dishonor. NAFTA (North American Free trade agreement) is one such policy implemented by United States, Canada and Mexico for the sake of promotion of free trade among them (Villareal & Ferguson, 2017). It is one of the most popular free trade agreements due to the reason that it is impacting more number of people in the region by way of the value of the goods and services involved in this trade. Though the Free trade agreement NAFTA was brought into limelight as early as 1998, the actual removal of the restrictions and enabling a fair free trade did not happen till the recent years like in 2008. Protectionist policies and barriers are very significant barriers to free trade. They are nothing but government imposed restrictions on the free international exchange of goods as well as services. Trade barriers can be of several types. Some of the important types of the barriers include, import policies that do include certain types of tariffs and other import charges for the sake of licensing and customs practices as well. Also there are certain types of the testing, labeling and certifications requirements governments can impose to restrict the free trade. Suppose governments are involved in direct procurement, then there can be privileges to certain type of business operations and there can restrictions to the free trade. Local exporters can be provided with subsidies, Also enabling flexibility to remove copy right protection and restricting Foreign direct investment are some of the other ways of creating barriers to the free trade as a means of protecting the interests of the national and local companies. There are varieties of provisions created by United States government in its attempts to safeguard the interest of the local manufacturers in the recent years. For example Lenovo the Chinese PC manufacturer has suffered serious complications with the tariff rates introduced by US to protect the local PC manufacturers. The otherwise economic and profitable goods of Lenovo which are technically competent and profitable for US consumers are now overtook by the local companies. This is two way disadvantage, consumers are not directly getting the benefit of the cheaper products and not getting the necessary consumer power at the same time competitiveness in the industry will also detoriate due to the protectionist policies. Also it is unfair against to the free trade policies of the global countries (Ferraini & Gwarteny, 2018).
Question 2: What are the principal arguments supporting free trade? (1 page, single spaced)
Answer: Principal arguments supporting the free trade:
• Free trade theoretically will work on to support both the trading partners. This is mainly due to the reason that the both sides of the trading partners can able to take up the best advantage of the aspect in which they are good in. Trading partners can able to maximize their comparative advantage as the free trade will provide them maximum provision to take up the advantage of the situation. The process will work on to provide economic efficiency and will also work to increase economic efficiency in general. There is good scope for the reduction of the prices in the free trade environment. This is applicable for any particular domestic setting as well as international setting as well(Irwin, 2015).
• Free trade will also work to provide opportunity to give fair exchange of the exotic products. Such provision will provide consumers more and more access to diverse set of goods. Availability of the variety of goods will improve the quality of life as well consumer satisfaction. When there is reduction in the prices of the goods consumers can have access to the exotic goods, their quality of life and consumption will also get improved. As a whole consumer satisfaction will improve a sense of fair trade prevails (Bhagwati, 2017).
• Comparative advantage can be taken as a merit for the maximum extent of using free trade business. Free trade business will let the countries take up the lower opportunity costing for better business and comparative business promotion. Such advantage will work for the betterment of the economic welfare of all the trading partners ( all participant countries). Comparative advantage will work on to let fair sharing of the resources. When there is advantage of certain raw material availability, the country can actually get benefit of this situation by selling the same to the trading partners. Comparative advantage will work to ensure more efficiency and effectiveness. When they do specialize in certain type of operations or the trade, the outcomes of the same and quality of the deliverable is also likely to be superior.
• Free trade will contribute to the fall or removal of the tariffs on the imported products and this inturn will impact the prices of the final products. Consumers will able to get the products at very low prices and hence it is an advantage to the country or the countries involved in free trade business.
• Free trade will contribute to the increase in the exports as well. Lower tariffs on specific countries or the products (Free trade partners) will boost up the business by creating ample jobs and economic growth. This situation can be constructive too, both the trading partners can experience win-win situation, by exporting the products the first country will gain advantage and by receiving the same specialist products the receiving company will also get advantage of boosting its own internal business opportunities.
• There is also fair opportunity for the improvement of the economies of scale and subsequent fall in the overall price of the commodities, Increased competition and thereby added value and quality to the products and the services. Further absence of tariffs system will improve the trade efficiency and will also works as an engine of growth. Further there is wide scope to make use of otherwise dead stock or surplus raw materials. Better and efficient distribution of the goods and the services is possible with the usage of free trade principles in general.
• Most of the economists united to support the claim and the fact that the free trade is an economic growth opportunity and is a contributor of living standards as well. This is true and proven fact, there are economic reflections which are proven and supported this claimant.
• All-round prosperity, global co-operation, competitive spirit and accessibility to locally unavailable material and products, free trade without scope for interference from beauracratic governance are some of the immediate pro-arguments for free trade.
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Question 3: What are the principal arguments against free trade? (1 page, single spaced)
Answer: Principal arguments against the free trade:
• One of the chief concerns of free trade is the disruption in the workforce dynamics. It is possible that the most of the countries will start to expand their operations as there will be no import tariffs on their products. This is a great advantage to the countries, where the labor force is available for cheaper price and this in turn will contribute to reduce the overall cost of the products. This is a disadvantage as well to the countries like United States, where in the cost of the manufacturing is high and the products prices cannot be competed like those from cheap labor countries. Such situation will prompt the companies in such countries to involve in outsourcing of the jobs. Outsourcing of the jobs will disrupt the jobs in the parent country. NAFTA is one popular free trade agreement and is condemned for the issues of job relocation to the countries like Mexico. Such complications are unavoidable in Free trade regime.
• In most of the countries like developing countries, the trade protection laws are very strict. For example intellectual property rights are not very strong, In such conditions, it is quite easy to copy the intellectual property rights of these countries. This in turn will work for the domestic knock offs to take advantage of huge investment of the original companies in R&D and product development. The copy cats can make products at very less price and creates disruption to the original company business revenues on trade.
• Outsourcing and the possible exploitation of the working force will create inhumane working conditions. Children and women will become scape- goats of the poor working conditions ingeneral. Natural resources need to be protected by well designed and matured laws and regulations in general. When there are no proper policies to protect the natural resources, it is possible for extensive degradation of the local regimes. Greenery will be lost, deforestation will happen and there is possible lost of diverse other natural resources as well. Small developing countries exclusively will depend on the import tariffs and revenues. When free trade eliminates such possibility, they lose the possible tariff and related revenues.
• There are also arguments suppressing the free trade in the context of the national security. Defense is very sensitive domain, where in the national security interests will get impacted when there are free trade provisions enabled into this sector. Both the dumping as well as protectionism can create complications to few countries in the game. For example united states economic experts, since a long time are arguing that allowing free dumping of goods into the country as well becoming the subject of protectionism in some other countries is giving unfair trade benefits to the country.
• There is considerable scope to believe that the inefficient industries will remain ineffective. As the trade policies will promote only competition and supports only the companies that do have the spirit to excel, the policies will not bother the companies to take care of alround development of the sick industries and hence they remain ineffective.
• Overdependence and consequential economic depression is inevitable in free trade environment. If one country catches the depression, all its trading partners also will be caught in the depression. There are evidences to such serious complications during the times of the Free trade in Euro zone. During the sovereign debt crisis, the free trade regimes which are further consolidated by single currency seriously got impacted. The crisis in one country has become uncontrollable (which otherwise would have curbed), spread to all other countries and created serious implications to all the countries. Uncontrollable problems can be created to all the member states of the free trade due to cyclic reactions of the problems. Interdependence will augment these problems very seriously.
Question 4: What regimes exist to promote free trade globally? (1 page, single spaced)
Answer: Regimes existing to promote free trade globally:
WTO (World trade organization) is the regime working for the promotion of the free trade on global framework. WTO has about 60 agreements, annexes, decisions as well related understandings. Comprehensively with all these features, WTO works for the betterment of the international trade and works for the governance in the domains of the goods, services, intellectual properties, dispute settlements as well as trade policy reviews. Considering all these facets WTO works for the betterment and encouragement of the global free trade(Hoda, 2018).
WTO works for the improvement of the standard of living of the people.
Full employment and provision of the improvement in the effective demand is another important aspect of WTO.
Enlarging the production and the goods trade is another key function of WTO
Improving the trade of all services is another important functional aspect of WTO.
WTO works for enabling optimum usage of global natural resources
WTO enables the protection of the environment and will contribute for the sustenance of the global resources as well. International organizations like WMF and IBRD will be supported by WTO in establishing coherence in world Economic policy determination and for making related protocols.
Following are the some of the regimes promoted free trade in the historical time lines,
GATT(The general agreement on Tariffs and Trade) - It is an international organization set up in the year 1947 to facilitate the free trade on multi lateral basis. There are variety of foundations for the formation of the GATT. Free trade is assumed to be better than the regulated trade by GATT. Free trade is best guaranteed by multi lateral agreements in GATT formation. They are formed and facilitated by the presence of the GATT as a regulatory agency.
Apart from the above regimes Free trade groups are also working for effective implementation of the world free trade. Free trade Areas (FTA) are some of the regimes where in the participant countries will undergo an agreement for free trade when collectively undertake multi-lateral understandings for removal of all possible trade barriers. Examples of such regimes include NAFTA (North America Free Trade Area), ASEAN-China Free trade Area as well as EU(European Union) Free trade area.
Another such significant trade area regime is Customs Unions. Customs Unions are results of the negotiations, which will create a common free trade area along with commonly agreed and accepted tariff rates. Examples of such regimes include Union of Kazakhstan, Belarus and Russia and Arab customs union etc.
When there is understanding for the formation of the free trade area along with customs union as well with co-ordination for the formation of economic policies such as monetary exchanges, then it is called as common market. Examples of the common market will include EU eurozone, southern Zone common market (Mercosur) etc.
Cartels are unions of trade organizations which are formed to facilitate fair trade in the business areas such as energy, fuel, coffee items etc. They are formed to let all the stakeholders get fair deal of business and returns in the due course of trade operations.
Though still there are some contrary remarks there in force against WTO, as of now this is the organization working for ensuring fair deal of operations of some of the countries which do fall within the framework of its operations. When they face any type of retaliatory operations by some of the countries, then in response to the same, they can appeal to WTO and WTO cannot negotiate with the same to ensure proper action be taken in that regard.
Question 5: Why are they now beginning to question the US's abandonment of basic manufacturing capabilities?
Answer: The law of comparative advantage holds that the countries can focus on the production of the goods where they do have comparative advantage. Rather than producing each and every good that they can produce, countries can stick to the production of the goods, where they are good in and production of the same can have significant comparative advantage to it. When applied this perspective to the manufacturing tendencies of United States of America, it is observed that United States of America has gained advantage in developing high tech products. As it has good comparative advantage in manufacturing such products, US has taken up extensive production of diverse high tech products while completely abandoned several basic manufacturing products. Economic crisis of 2008-2009 has created introspection of the United States policy of abandonment of basic manufacturing capabilities(Siems,2018).
In light of the economic crisis, the myths of the comparative advantages of the United states started being focused by the economic experts, as the fallacy contained in abandoning the basic manufacturing operations is sensed at that time. One of the most prominent characteristic features that worked on to high light the fallacy of this model includes the fact that the country will be strong enough only when it has capacity to stand for foreign competition. But there is no need to abandon completely the basic manufacturing operations in the country. This is due to the reason that the gain will not depend absolutely over the gain the country will gain in the due course of time, rather it will depend on the relative gains the company will get when compared with other countries in the game as well. Hence when compared on global perspective, there are several other countries on the globe, whose operations are poor and not very productive when compared with United States, comparative advantages in the operations of the basic manufacturing operations, hence it is not very much appropriate for the country to abandon the same for high tech products.
Another reasoning that prompted economic experts to think in this direction is the fact that the high wages are not the only factors that are against the dependence on the production in these countries. For example, when a high wage country like united states is mainly depending on its production operations with high wage labor and is working out for comparative advantage with the lower wage countries, it is considered not advisable as is not profitable. However it need not be totally true, since wage of the labor is not everything of the production, this can be considered only one of the key factors of the production, but other factors of the production will collectively will decide the profitability of the operations in the country. Hence typical factors like efficiency of production may decide the ultimate production volumes and the profitability of the countries. Hence considering other factors of the production like surplus availability of the raw materials, production efficiency, logistics feasibility etc United States can ignore its negative advantage in the labor wage. Another important consideration is the fact that the profile of production operations does keep changing, there is extensive inclusion of the technology and the maturity of the technological operations in the production and hence this can change the profile of the production operations. Technology innovations and implementation of the same in the production operations has changed a lot the extent of the efficiency of the production operations. High end production effectiveness was actually materialized with these changes and hence the old perceptions of the infectivity associated with the basic manufacturing operations can be requisitioned and fresh outlook towards the same can be thought of. Inlight of global economic crisis, fresh introspection has been considered by economists and the abandonment of basic manufacturing operations has been focused on with emphasis on possible reversing of the wheel.
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Question 6: It is generally agreed that China has done everything possible to avoid pursuing free-trade policies. Briefly explain. How do they get away with it?
Answer: China has established free trade zones to quickly attract, foreign direct investment into the country, however still it is not very much in the same phase and pulse with other free trade zones in the world. "Free", in the free trade zone in the country is a highly qualifying descriptor and there is need for the country to consider so many other factors to discuss and comprehensively cover the free trade zone description of the country (Lanteigne,2015).
Often the country exhibited the intense trade regulations and the complex and cumbersome operations for trading in the country. When it comes to approve the foreign capital into the country, it is even more complex and difficult. In this connection, little facilitation of relief of these complexities paved way for making China free trade options a little better than before option for FDI. The procedures and associated complexities are reduced a little. Further some targeted sectors like banking institutions have received additional attention to get attracted into the free trade zones, already several foreign banks gained entry into these free trade zone areas.
Though the banks were given freedom in facilitating the attraction of the FDIs into the country (into the free trade zone) there are still some limitations in the due course. China Government has created an invisible currency wall, which works on to limit the infusion of the currency into the other parts of the nation's economy. This is mainly working for the prevention of the leakage of the funds into the rest of the country, which can prevent the damage to the economy of the rest of the country. Further it is required to accept the fact that there is no complete freedom and free trade, there is an extensive negative list with about 200 and more list of items. This is an indication that the business in China is not totally free and still there are regulations exist inspite of existence of controlled environment in this region. Also there are provisions on the classified asset building initiatives like developing villas in the Free trade zones, there are exclusively to control to the real estate prices to shooting up, it is an indication of the measures taken to control the speculation in the wake of Free trade zones in the country. Hence with such an approach, China managed to project itself as one of the countries looking for augmenting the free trade and at the same time managed to keep up its interests and commitment towards long legacy of protecting its own interests and its national organizational business interests. Collectively it is illustration of unique approach; China is exhibiting to get away with everything possible to avoid pursuing free-trade policies.
Question 1: How are currency exchange rates established?
Answer: The economies of the countries depend heavily on the international trade will depend more on the currency exchange rates. Currency exchange rate of the country and its trading partners will collectively impact the economies of the country in focus. Trading of the same, Policies and governance of the currency rates will decide well the operation of the national economies in general.
Establishment of the currency exchange rates:
The establishment of the currency rate is linked to the amount of gold; the country is there in possession. This mode of currency valuation is there in force from several centuries, throughout the globe. United states Dollar and its valuation of the gold for one unit of dollar is taken as prominent unit by several other countries and their currency valuation is set based on these factors of valuation. However the valuation of the dollar against the gold has changed with time due to inflation and accordingly other currency valuations also changed with time. Since 1971, the gold standard of the United States dollar is withdrawn and purely market forces are now deciding the valuation of the currency exchange rates of different countries. However still now the United States dollars and Euro currency is accounting for a standard valuation of diverse countries in the world. British pounds, Australian dollars and Canadian dollars are working as referential currency rates for different countries of the world as of now.
There are diverse forces that impact the currency exchange rates in general. If the demand for a particular currency is increased from a different country, then the exchange rate of the demanded currency will increase. For example if the demand for United States dollar is increased from Canadians, then the exchange rate of United States dollar for Canadian dollar will increase. Numerous factors will collectively decide the floating rates of the currencies. Market forces of supply and demand will impact the currency rates in general. There are countless geo-political and economic factors to affect the exchange rates in general between two countries. Few of the most common factors include the interest rates prevailing in these two countries, unemployment rates in the two countries, inflation reports, Gross domestic product numbers, data of manufacturing and commodities all will collectively impact the currency exchanges rates between the two countries in comparison. Gross domestic production of a particular product will also influence the currency exchange rates of particular country in floating exchange rates framework. For example, considering an oil producing country like Canada, if the revenues of the country are dependent on the oil and if the prices of the oil hikes up, the currency exchange rates of the canda also will get appreciated. Similarly for the country like Australia, if the gold price is increased, the currency valuation of Australia will also increase. The correlation between the commodity prices and the currency valuation will decide the absolute currency valuation of the country. Forex-commodity correlations best explains these exchange rate setting up processes and the fixations. Pegged rates are also maintained by some countries, where in chronically,(Periodically), the prices of the currency rates will be decided and set by the country artificially and will be maintained(Della Corte et al.,2018).
Question 2: In the light of your response to question 1, explain what steps a national government takes to strengthen or weaken the exchange rate of its currency.
Answer: Exchange rates of its own currency can either be hiked or reduced by its own internal policies of the country. For example a country may work on reduce the price of the currency of the country by undertaking purchase of its own currency. For example countries like china purchased about $1.4 trillion worth bonds from united states. These measures will work on to shoot up the exchange rates of the yuan. This in turn will also work for the reduction of the currency exchange rates of United States dollar. Charging higher and higher interests rates will also work on to appreciate the currency exchange rates.
When above discussed measures work for boosting up the exchange rates of the currencies. Reversing these measures will work on to weaken the exchange rates of the currency of the country. For example if the government borrows funds from other countries, then the currency of the country will get weakened in the open exchange rate market. Higher the debts, higher and higher will be the fall in the price of the exchange rates of the currency rates. Fiscal policies adopted by the country have greater impact in reducing the exchange rates of the country. For example if there are policies introduced to increase more and more inflow of currency into the country, then the exchange rates of the currency will also get reduced. Though the above measures are some of the several possibilities, plethora of considerations and actions are needed to strictly control the exchange pricing of the currency. If the exchange rate of the currency is to be controlled it is required to control supply and demand of the currency, inflation rates need to be controlled, when there is higher inflation, devaluation of the currency is the obvious development, if there is lower inflation there will be boost of the currency value and more and more investments will pour into the country. When there is hike in the interests rates, it is possible that the foreign currency will get dumped in from the countries with lower interest rates and this in turn will contribute to the increase in the valuation of the exchange rates. If the central bank interventions are stronger and effective, it is possible for the country to get higher and higher exchange rates. Other factors include economic outputs from the country, when there are higher and higher economic outputs, the valuation of the currency will be higher, Relationship between trading partners will also decide the currency exchange rates in general. For example Russia got sanctions and consequently the valuation of the currency got fallen down drastically. If the reserves of commodities with international transactability and demand got increased, they will contribute to the valuation of the currency. For example if the gold reserves of the country are increased, they will contribute to the hike in the value of the currency. At the same time the political stability, governance mechanism, ideology and philosophies of the countries all will decide the valuation of the currency. There is not a single factor that can effectively decide the exchange rates; rather a collective consideration of all these factors will decide the exchange rates of the currency (Harwit, 2016).
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Question 3: What role was played by the currency exchange rates of these countries to stimulate exports?
Answer: Japan has become an example of economic miracle between 1950 to 1980 by extensive export driven operations. The successful saga of Japan inspired several countries (notably the four dragons), Taiwan, South Korea, Singapore and HongKong. These four countries often called as Asian dragons worked on undergo rapid industrialization observed an extensive growth rate of about 7% per year during their peak economic growth phase; they got developed into high income nations, industrialized and developed with specialization in competitive advantage. Singapore and Hong-Kong became leading international financial centers. At the same time Taiwan and South Korea recorded unprecedented growth in information technology and related manufacturing sectors. Rapid industrialization and export orientation made this change possible for these countries and the economic growth of the country recorded values which are quite high starting from 1965. Asian dragons attained the status of the world's wealthiest nations and even South Korea surpassed the GDP rates of Japan by 2015 and became second only to China. The bulk of the imports in the country will hold and decide the exchange rates of the country in general. The supply and demand of the currencies will finally decide the fluctuation of the valuation of these currencies.
Singapore economic analysis in the export regimes through a long historical timelines of action proved that the higher the imported input content, the impact of the exchange rate changes will be less on the export competitiveness. Re-exports are proved to have least impact due to the currency changes. However still the productivity gains can have impact over the pricing of the exports ingeneral. But still the value addition in the exports of the Singapore needs to be compared again with the total extent of the imports undertaken by the country. When the total volume of the total imports is higher than the value addition, then the export competitiveness will not be higher. Also as there is increase in the lot of exports, the critical leverage in the export competitiveness will diminish. This is practically seen in Singapore and the exchange rate impact is not much in the Singapore export competitiveness, a cumulative impact of several factors worked on to impact the final export competitiveness in the country (Abeysinghe & Yeok, 1998). Similar observations are reported in literature in the quantitative evaluation of the impact of the exchange rates and their volatility on the export competitiveness in general. The impact of the exchange rate has statistically significant negative impact on real exports in most of the countries in general. There are few reasoning proposed in this regard. To explain the same, it is required to emphasize few factors like risk averse exporters will reduce their activities heavily when there is exchange volatility. Normally these stakeholders will change over the sources of the supply, demand or they even work on to change the prices, for the sake of minimizing their exposure to the influence of the exchange risk. Trading patterns and trading feasibility has lost its effectiveness in the times of the exchange volatility. There are instances of substantial fluctuation in the variability of the exchange rates and they do impact the influence of the demand for the exports in general (Poon et al., 2005). There is evidence to the similar trends observed in the South Korea export trends, volatility of the exchange rates has impacted the Export competitiveness of the country in general. Engle-Granger Residual co integrating technique is employed to study the exchange rate fluctuation and the related impact of the export trends and negative relationship is observed between these two(Doganlar,2002). In the times of currency volatility, South Korean companies have observed to do trading in the domestic domains than to move to the external regimes. There is evidence in all dragon countries as well as in other global countries that the positive impact of the depreciation is offset by the negative impact of the currency exchange rate fluctuations. The net impact is a negative impact over the net export competitiveness of the country. In Singapore it has created a net negative impact on the export competitiveness (Jin, 2017). For Korea there are evidences of creation of net zero impact on the export competitiveness due to collective effect of currency rate volatility and the depreciation's positive impact(Tang et al.,2015).
Question 4: Explain how a cheap RMB both helps and hurts China's economic prospects.
Answer: China worked out to keep its Renminbi (RMB) as cheap as possible to boost up its trade performance. Creation of such artificial cheapness worked out to boost up the performance of the country's trade performance. Economic prospects can be influenced in mixed tone by cheap currency. A cheap currency can impact the trade performance and the economic prospects both positively and negatively. Some of the positive implications are more rationally assumed and are based on intentional manipulations, the negative implications are uncertain and they can stem from several possible developments. It is possible that they can stem from counter actions of United States and several other countries in general.
In general when the country managed to make its currency cheaper, the attractiveness of its exports will grow higher. More and more people will take up the exports when the currency devaluation is observed. There will be prospects for the country in terms of increased exports when the country currency value is less. China's leadership wanted to keep its currency more as an international reserve currency. Such gesture will work on to let the global market forces influence and to weaken the Yuan value in general. Apart from this, there is also attempt to keep the currency more market driven for obvious trade advantages. This is the underlying strategy of the china's leadership in making the currency cheaper.
With devaluation of the currency and opening gates to let the market forces control the value of the china currency, there is wide chance for the market forces to play a bigger role in determining the value of the RMB. Such measures will let the PBOC to provide more and more power in setting up higher domestic rates in general. This can be considered as an advantage in terms of setting up the monetary policy with more flexibility. Another important implication of the RMB attaining international currency status, is the hedging of the funding risk by the country. The country has attained the status of the reserve currency and this inturn will work on to enhance the demand for the RMB denominated assets on long time. This substantially contributes to let the Chinese government to issue debts in RMB much higher than at present. This will contribute to limit the share of the China's liabilities in its own currency. The risk of currency mismatch will get reduced. Similar implications can be seen for the overall funding risks of the country on long run. Liquidity and stability are possible advantages for Chinese RMB in future. When more and more usage of RMB is observed in settlements, it will create more liquid currency market for RMB. This inturn is conducive for more flexible exchange rate of the Chinese currency in the long term. This can have implications to develop china into an international financial center in long turn. China's domestic markets will get more and more integrated with financial services with the global players, which can contribute to the economic power of the country.
However there are negative aspects of this development too. The imports of the country will get greatly impacted with devaluation of the currency in general. Chen Yuan & Baker et al (2004) proved that there is considerable scope for the nation to get mileage with the devaluation of the currency; there is more and more scope for the country to get more and more flexible exchange rate regimes on long runs with increased global prominence of RMB. Luo (2012) indicated that the prominence of china with devaluation of RMB will pave ways to consolidate and contribute to the objectives of the country which were shaped for years in the direction of economic empowerment; the new financial policies are more likely to establish Shanghai as an International Financial Centers (IFCs). Macro economic imbalances are more likely to get managed with the adjustment of the RMB as international currency factor.
Though it need not happen concretely, but there is scope for the escalation of the situation into a general trade war. All the countries participating in the trade war are likely to decline the valuation of their currencies and this in turn can result in the overall decline in the international trade. A common importer can face the complications of losing the purchasing power, due to the general fall in the valuation of the currency. Devaluation will also immediately hurt the countries that are exporting large quantities of commodities to the country like China. China is importing large quantities of commodities from countries like Brazil, Australia and Indonesia and they are going to get impacted with the devaluation of the currency.
As a whole it is to be agreed that in the slower export and stronger US dollar market, what china has done has a good reasoning and rationale. It has rightly worked out to let the Yuan depreciate consistently with the market fundamentals and hence the desire of the leaders to switch the country from a more domestically consumption oriented as well as domestic service based economy to more a global economy can be achieved here-in. China moves are working for the send ripples across global financial systems and more and more rival economies are preparing themselves for similar actions. The final outcomes of the actions of the china will be sensed soon and the time will decide the final bottom-line for the country.
Whether the china will meet its objectives by devaluation of the currency or not is another matter, however still the country is facing complications in terms of inviting fresh complaints from United States regarding the currency manipulation. The current situation of the high debt to GDP ratio as well as the situation which is discouraging lending and the risk of the capital outflows, PBOC is tightening monetary policies (Wei, 2015). The current situation can be a counter impactive development in this direction. The counter actions of United States can prompt China selling up the Treasury bonds of United States and such developments will enable US to raise its interest rates to the roof and subsequently it is possible for the country to develop serious risk of global financial stability.
China like countries are succumbing to devaluation of the currency for the sake of promotion of their own capabilities as international financial services. The long term implications of the same are yet to be seen and hence an appropriate reaction which can be taken after certain time can have very good implications to the consolidation of the economy of United States.
Question 5: Why did the US government pursue a strong dollar policy for so many decades? Since the economic crisis of 2008-2009, the dollar has weakened considerably against other key currencies, yet the Federal Reserve and Treasury Department have not taken steps to strengthen it. Why not?
Answer: Along with the changes in the global economic equations, the currency valuation is also changing. Once English pound is the strongest and in the aftermath of the WWII, US dollar has gained prominence by attaining the stronger currency status. A strong currency with relatively higher exchange rate is an important factor that can contribute to the consolidation of the global financial system. Strong dollar policy has ruled by the United States for several decades till the onset of the economic crisis in the year 2008-2009. In the aftermath of the same, United States did not focus much on the consolidation of the dollar value and the dollar value has weakened considerably against other key currency values.
Understanding the devaluation of the United States dollar need to be understood by understanding by global economics and currency dynamics. There is no single factor responsible for setting the value of the dollar in general. Though the internal measures of strengthening the dollar value continue as they are before, it is more likely that the valuation of the dollar will reduce due to variety of reasons like strengthening of the global economy. Recovery of the global economy will work on to effect the strength and the value of the dollar and that will address the relative devaluation of the currency. Capital flows to the countries will continue where there is extensive growth and investment returns are higher as well. Global risk aversion and the global economy downturns of that time viewed that the United States dollar is the safe haven and the investment continued into the same with extensive capital inflows. But now the situation is changed, global economy has boosted in multiple directions and the countries are now moving ahead not just with US dollar as the prominent reliance, there are other ways of safe investment as well. Several currencies now boosted to the status of the international financial currencies and hence the US dollar devaluation is perceived an obvious phenomenon.
Another important concern that is making US government not to focus too high on the dollar devaluation is the fact that the United States dollar undergoes cyclic changes in the valuation for every 5 to 10 years of the cycle time. Hence if by any chance if the devaluation of the dollar is seen, it is not likely that the dollar is undergoing a fall in price, rather it can shoot up to the normal price as per the cyclic variation in the prices and hence is not a serious cause of concern.
The effect of the weaker exchange rate on inflation is not very big in United States. More and more trade contracts are being executed in United States dollars than in any other country. As long as the domination of the United States dollar continues in the international trade, there is no much need to worry for the value of the dollar and the current status quo need to be continued as well.
There are factors like financial health that prompts the United States and its implications to the dollar values. With better and better financial health of the United States, it is more likely that the dollar value can consolidate by itself. However there is no need for such immediate concern by the government and to focus on the huge debts that are devaluating the value of the dollar in the country. It is due to the fact that the dollar value is depreciating due to huge debt and financial ill health, but it is just one of the several other factors that working for the devaluation and hence need to be considered too significant. There are also apprehensions there to control the possible china selling of the T-bonds to control the devaluation of the United States dollars, but it is not necessarily needed immediately, it is due to the fact that countries like china simply cannot stop exporting to United States and simply cannot stop taking up the dollars from the country. Hence there is no need to take up any apprehensions in controlling the selling of the T-bonds by china. Measures like increasing the interest rates may be useful but they alone will not decide the final valuation of the dollar, there are several other factors like trade flows and economic trends which collectively will decide the final price of the dollar and hence there is no need for the Federal government to immediately focus on the consolidation of the dollar value as in its pre-economic crisis economic policies.
Collapsing of the currency values is observed there from multiple currencies. Apart from other currencies United States currency is collapsing, but still the rate of collapse is not as intense as other currencies of the globe. Considering the emerging economic changes and the related developments occurring throughout the world, there is no need for the federal government to worry for consolidating the valuation of the United States. Also, there are few political ideological reasons like recent political changes induced protectionist policies in United States and their implicated regulations on free trade. They consequently impacted the value of the dollar as external investors reduced their FDI into the country. In any case these political changes can be temporary and the long term implications of the same can be surpassed by several other possible developments in the country. Hence considering all these implications of the present days and by considering the relative strength of the dollar, there is no immediate danger of the devaluation of the dollar. So there is no need to take up any sort of immediate corrective measures in this regard.
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Question 6: Briefly explain how the economic problems experienced by the PIGS in 2008 through 2010 surfaced significant weaknesses of implementing a one currency policy across Europe.
Answer: Euro was to established as a single currency for entire European union, Euro-zone. Single currency can have immediate advantages in terms of the improved overall economic performance, however it cannot be ignored of the complications and the possible crisis that can be rooted with having single currency like the incident that has occurred in PIIGS of Europe. PIIGS is the acronym for the countries of Portugal, Ireland, Greece and Spain at the outset, later Italy also joined the group. The entire crisis started with the unbearable public and private debt in these countries (Blikstad et al., 2017).
The growing instability of the PIIGS currency is fueled by the mono-currency structure. The fall of the real estate rates and the fall in value of the financial transactions worked on to create imbalances in all these member countries uniformly and hence there is considerable uncontrollable crisis surfaced due to the single currency system. Otherwise the severity of the crisis would not have evoked so much and also the chain reactions would not have triggered in all these countries. This is a serious weakness surfaced during the PIIGS crisis.
Eurozone cost containment policy has seriously impacted the balnace of all the member countries and seriously hiked the imbalance of these countires with other external countries as a whole.
Greece is a member country which is impacted heavily by the economic crisis, but still the implications of the Greece deficits got transferred to all other nations which are sharing uniformly the common currency of Euro in Eurozone.
The key advantage of the economic union by monetary policy have actually worked for the consolidation of the benefits of the economic conditoins like levaing the costs associated with the foreign exchange, trade with the outside leaves favored and therefore working for the increase of the same. Monetary integration leading to the integration of the fluctuating markets and subsequent benefits in terms of lower interest rates would have worked for the benefit of the member countries. However still the integration of this framework actually not provided with the advantage rather disadvantage to PIIGS group. The otherwise constrainable developmennt in Greece has actualy worked on to spread in all other countries and resulted in serious implications to these nations.
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