Academy Model United Nations 2012

Academy Model United Nations 2012

Bergen County Academies

International Monetary Fund

Sarah Rothstein

Hope Yi

Topic 2: The US Dollar vs. the Chinese Renminbi

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Introduction

How does the IMF Reserve Work?

Circa ten years after the Great Depression swept the international market, the International Monetary Fund (IMF) was established to avoid a repeat of the competitive devaluations that had contributed to the economic catastrophe; IMF exists to build a framework for economic cooperation on a global scale.

With this goal in mind, the IMF issues Special Drawing Rights (SDRs), an international reserve asset that can supplement the official reserves of the participating nations in order to support a fixed exchange system. In other words, SDRs are allocated by the IMF to the 187 IMF member countries, and the countries may convert these allocated SDRs into cash through a system of swaps manned by the IMF. This keeps the international currency system on a common ground, regardless of the difference types of currency that exist in each country. In order to keep the standard consistent, SDRs are given values based on the four main international currencies: the US dollar, the euro, the Japanese yen, and the British pound sterling.

Generally, SDRs are used by the governments of developed and developing countries alike to stimulate a stagnant economy, substitute dried up investments, boost spending on social programs, etc.

The Issue

The Chinese Economy

China is ranked third in the world’s largest economies and second of the largest trading nations. In the context of the IMF, China plays a key role, since it holds the largest amount of foreign exchange reserves in the world; there is actually a surplus in China’s foreign reserve account that is equivalent to 10.5% of its annual economic output!

In order to maintain its strong economy, the Chinese government is aware that the country’s total consumption needs to be increased in the long run. Therefore, it is allowing the value of the Renminbi (RMB) to appreciate. Raising the value of the RMB reduces the cost of imports, thereby, increasing the real value of household income; this will allow for a rebalancing of the Chinese economy. However, this must be done at a steady pace, for a rapid increase of the RMB will not lead to an increase in consumption, but a decrease. Therefore, the Chinese keep the value of the RMB relatively low, hoping to increase it progressively to suit long run economic goals.

The United States Economy

The value of the dollar has abruptly declined by 10% since June 2010. With the United States as a major global power, the country’s weakening currency is causing the delicate balance of world economies to become further disturbed, as it continues to recover from past financial crises. If the United States cannot pick up their low interest rates and declining dollar, investors will be prone to resort to other foreign markets, overheating those countries’ respective economies. Furthermore, such weakness of the United States economy can poorly reflect the perception of the country as a whole.

In order to attempt to spur growth, the Federal Reserve has injected great sums of money into the economy, through a process called quantitative easing. Moreover, the United States, in its belief that China is manipulating its economy, is demanding immediate action from China (which needs to adjust its value of the RMB gradually to avoid overheating); according to IMF reports, a 20% trade-weighted appreciation on the Chinese RMB could result in a 0.05-0.07% increase in the growth of the US economy. Thus, it is in the best interest of the United States to push China to have the RMB appreciate rapidly, and it will forcefully do so by means of tariffs, trade restrictions, etc.; however, such rapid appreciation is the direct opposite of China’s economic goals.

In short, the United States needs to balance its trade with China: the United States has a deficit with China, while China has a surplus with the United States. Such imbalance is bound to affect the global economy as both countries are economic leaders.

The Global Perspective

Due to the decline of the dollar, industrialized economies, especially ones that work cohesively with the United States, such as Japan, Britain, etc. are struggling.

On the other hand, emerging markets, such as those in Latin America and in Asian countries (similarly to China) are soaring due to the dollar’s decline, since investors are beginning to resort to such countries’ markets over that of the United States. However, the downside is that these nations are at risk of overheating (strong demand not met by increased supply, causing inflation), since their domestic economics are attracting floods of speculative capital seeking higher interest rates.These nations, particularly Brazil, South Korea, and Indonesia, have enacted capital controls to strengthen their banking systems and lower interest rates.

Furthermore, it is important to note the role of Germany and Japan, countries that were also pressured to appreciate their currencies; however, unlike China, these countries gave in to pressure, since they were militarily dependent on the United States in the 1970s. The current matter between the United States and China can be applied especially to the latter of the two countries, as seen through the Plaza Accord of 1985, for which the doubled value of the Japanese yen was a result.

Possible Solutions and Scenarios

Pressured Appreciation of the RMB

The IMF can have China’s economy geared more towards a consumer-driven growth model, as opposed to its current reliance on exports and investment. This change may have to come at the expense of the Chinese economy, one whose potential currency appreciation may or may not have considerable power over the global market.

Internationalization of the RMB

As China is a major player in global trade and the world’s leading exporter, it makes sense to increase the use of RMB to invoice and settle global trade, parallel to the four major economic currencies.

However, if China were to be included in the basket of main global currencies, economists speculate the addition of the RMB may replace the British pound sterling and Japanese yen, in terms of SDR currency exchanges. Furthermore, as China endeavors to fix the exchange rate of the US dollar at one level while the US is simultaneously starting to intervene in the foreign exchange market at another level, conflict would be inevitable.

Questions to Consider

1. What are the strengths and weaknesses of internationalizing the Chinese RMB, relative to global financial stability?

2. What constitutes a currency war, and what can be done to avoid one?

3. Taking into account the political system of each country, what would the optimal courses of action be for the participating countries of IMF?

4. China is an independent geopolitical power that can resist pressure to change its exchange-rate policy—how can it be made motivated to make changes to benefit the rest of the world? Should it make changes?

Works Cited

International Monetary Fund (IMF) Website

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