If the United States Loses Its Aaa Rating Will China Raise the Value of the Yuan Against the Dollar?

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Thursday, 21 April 2011 04:23

This is the logical implication of the threats reported in a Reuters article, saying that China would cut back its investment in U.S. government bonds if the United States loses its Aaa credit rating. The article implied that this threat is something that would be scary to the Obama administration.

In fact, it should not be scary at all, since China is effectively threatening to do exactly what the Obama administration claims it is asking them to do. The Obama administration claims that it wants China to raise the value of its currency against the dollar. The way that China keeps the value of its currency down is by using the dollars it accumulates as a result of its large trade surplus to buy government bonds and other dollar denominated assets.

If China stopped buying government bonds, then the dollar would fall against the yuan (i.e. the yuan would rise), exactly what the Obama administration supposedly wants. This would make Chinese goods more expensive in the United States, leading us to buy fewer imports from China, and it would make U.S. exports cheaper in China, leading China to purchase more U.S. exports.

This sort of adjustment is necessary to get the U.S. economy on a stable growth path. Therefore this threat from China should have been viewed as a positive development. It was not reported this way.