Case scenario: China and the Value of the Yuan
Prior to the financial crisis on 2007/2008 the US Treasury Department as well as Congress had been asking China to revalue upwards the value of their Renminbi or Yuan. China responded to these repeated requests by allowing the Yuan to trade within a narrow band. The band itself was then shifted upwards or downwards by small increments from time to time. Still, the US claimed that China had not done enough and should raise the value of the Yuan by at least a further 20%. The reasons given to justify this requested increase were as follows:
1. The artificially low value of the Yuan makes US manufactured exports unattractively priced in China.
2. The undervalued Yuan leads to excessive US imports of Chinese made goods which in turn leads to an unwelcome trade balance in China's favor. For example, the trade deficit with China was roughly $20 billion for the month of May, 2007. The total trade deficit for the US for 2008 was roughly $700 billion. These numbers shrunk during 2009 as recession hit the global economy. But now they are growing again. In the month of May, 2010 the trade balance was -222 billion and for all of 2010 roughly -273 billion.
China chose to change their 'floating' arrangement and pegged the Yuan to the USD at a rate they selected. The US continued to complain so China recently allowed the yuan to 'float' again. China holds such a large investment in US Treasuries as a reault of the continuing US trade surpluses that the US does not have a great deal of leverage. If China sold those Treasuries the US dollar would fall significantly in value.
Suppose China suddenly decided to change its mind. Overnight, instead of increasing its value China decided to devalue downwards the Yuan by 20% in order to increase the attractiveness of its exports.
Then consider the impact this decrease in value of the Yuan would have on two large US companies: (1) Yum!Brands whose 2009 profits before tax were $1.396bn roughly b45% coming from their Chinese operations. and (2) Wal-Mart where the great majority of the products sold in its US stores are made in China.
Explain what each company should do to protect themselves from such a major change in currency values.