Interview Question: Let the Currency Float

Sample Question #136 (economics – international finance)

Imagine that China just announced it would let its currency, the renminbi (aka the yuan) float freely. What do you think happens to its exchange rate against the U.S. dollar, and what happens to the respective interest rates in the U.S. and in China?

Do you think this event will affect the exchange rate between the dollar and the yen?

(Comment: a nice case-type question that tests your economic reasoning skills)

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3 Responses to Interview Question: Let the Currency Float

  1. Brett says:

    ANSWER
     
    Let’s assume you know, from reading the news, that everybody (except some Chinese officials) thinks the renminbi has been artificially undervalued.  So if it were to go float right now, it would appreciate against the U.S. dollar.  In the long run, though, its value vis-a-vis the USD is less certain, as the Chinese economy is far less robust than the U.S. one.
     
    An immediate appreciation in the renminbi drives investors to invest in the Chinese currency, thus driving down its interest rate.
     
    Hard to say whether it’ll affect the dollar-yen rate; it depends on whether the U.S. or Japan is more impacted by the float.
     

  2. Wu Chao says:

    Do we need to consider other aspects such as economy development will affect the exchange ratio such that when the economy development is greatly impaired, then the government will change the interest rate.BTW. My humble think is that RMB is not artificially undervalued a lot. It is a political game for US. Why  EU  does not act like US on the RMB ratio game so crazily? If RMB is depreciated a lot and it does not work for US, I firmly believe US government and other so-called independent analysts will have other reasons to blame China. Just see the 1997 Asia financial crisis.They played the game with Japan 15 years ago and so many Japanese suffer from that game. Now they want to play with China again. The US holds the hegemony and wants to control everything as its will. This RMB issue is just one example.

  3. Brett says:

    Good comment about the parallels with Japan! 

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