mgmt389 case - Chapter 11 closing case China's pegged...

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Chapter 11 closing case China’s pegged exchange rate. Summary The closing case describes China’s exchange rate policy. For nearly a decade, China has fixed its exchange rate to the dollar and bought or sold dollars to maintain the exchange rate. By early 2005 though, the country was feeling pressure both at home and abroad to let its currency, the Yuan, float freely against the dollar. Discussion of the case can revolve around the following questions: QUESTION 1: Why do you think the Chinese government originally pegged the value of the Yuan against the U.S. dollar? What were the benefits of doing this for China? What were the costs? ANSWER 1: China’s decision to peg its currency to the U.S. dollar provided for a more stable currency for China because it meant that the Yuan moved in lockstep with the value of the dollar - a currency that would be far more stable than the Yuan. However, the decision led to a situation that was not popular with the United States or other developed nations, as, over the next decade, the Yuan became undervalued by as much as 40 percent. This trend allowed China to increase its exports dramatically, while at the same time making it more difficult for foreign exporters to sell their products to China. Foreign companies manufacturing in China were able to capitalize on the undervalued Yuan, and reap the benefits of “cheap” exports. Recently, after years of rapid economic growth stimulated by exports, and amassing a stockpile of dollars valued at more than $700 billion, China faced significant pressure for currency revaluation. QUESTION 2: Over the last decade, many foreign firms have invested in China and used their Chinese factories to produce goods for export. If the Yuan is allowed to float freely against the U.S. dollar on the foreign exchange markets and appreciates in value, how might this affect the fortunes of those enterprises? ANSWER 2: Many students will probably agree that a stronger Yuan would probably result in a situation in which companies that currently export from China see some slowdown in their exports or a lower profit. QUESTION 3: How might a decision to let the Yuan float freely affect future foreign direct investment flows into China? ANSWER 3: If the Yuan is allowed to float freely against the dollar and appreciates in value, many foreign companies with investments in China may find it more difficult to export or see a drop in their revenues. Many students may suggest however, that even with a stronger currency China will continue to be a popular destination for investment because of its low wages.
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QUESTION 4: Under what circumstances might a decision to let the Yuan float freely destabilize the Chinese economy? What might be the global implications of this be? ANSWER 4: The effects of the weak Yuan are apparent in both the U.S. and China.
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mgmt389 case - Chapter 11 closing case China's pegged...

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