USD/CNY EXCHANGE RATE

The pegged exchange rate of the USD/CNY cannot last forever.
Market forces are too powerful to be successfully manipulated indefinitely.
We have already seen changes in the rate at which these two
currencies are pegged. On July 20, 2005, the People’s Bank of China
announced that it would be moving the fixed peg on the exchange
rate from 8.27 Chinese yuan per U.S. dollar to 8.11 Chinese yuan per

U.S. dollar. This move increased the value of the Chinese yuan and
decreased the value of the U.S. dollar—for a total movement of about
2 percent.
Let’s take a look at our supply-and-demand graphs to see
how this all works out. We begin with a basic supply-and-demand
chart (see Figure 9.2).

When the People’s Bank of China decided to reset the value of
the USD/CNY peg to represent an increase in strength for the Chinese
yuan, it meant that the Chinese government would not need to buy
as much U.S. debt to maintain the new peg rate. A decline in the purchasing
of U.S. debt will result in a subsequent decline in the demand
for the U.S. dollar. As demand for the U.S. dollar decreases, the
value of the U.S. dollar also decreases. You can see in Figure 9.3
how the price point for the U.S. dollar decreased as we decreased
the demand for the U.S. dollar.

If the People’s Bank of China decided to reset the value of the
USD/CNY peg to represent a decrease in strength for the Chinese
yuan, it would mean that the Chinese government would need to
buy more U.S. debt to maintain the new peg rate. An increase in the


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purchasing of U.S. debt will result in a subsequent increase in the
demand for the U.S. dollar. As demand for the U.S. dollar increases,
the value of the U.S. dollar also increases. You can see in Figure 9.4
how the price point for the U.S. dollar increased as we increased
the demand for the U.S. dollar.


China 121

China 121

U.S. dollar—demand rising, price rising
Price
Quantity


Demand
Supply


Source: Ouroboros Capital Management, LLC

You would be hard-pressed to find someone who believes that
the peg rate on the USD/CNY will be changed to reflect a weaker
Chinese yuan in the near future, but it is good to understand how
both sides of the equation work. Most people, in fact, believe that
the peg needs to be moved at least another 30 to 35 percent before
the true exchange rate will be reached. Hopefully, however, that
change will not happen overnight. Everybody will be much better off
if the peg can be carefully managed until it reaches a stable market
point within a year or two. If the peg were to move or be completely
eliminated too quickly, the global economy would be devastated on
a scale ten times as dramatic as the shock experienced after the Asian
financial crisis.