If the yuan/dollar peg is severed, the yuan will increase in value compared to the dollar.
1. This will instantly devalue the current holdings of dollar-denominated debt that the Chinese are holding, which is one of their largest balance sheet assets.
2. Chinese-made goods will increase in price, which will decrease the demand for their goods. They are an export-driven economy, and a significant decrease in their exports will hurt them far more than it hurts us.
3. A higher-value yuan, however, will be able to command greater purchasing power in dollar-denominated assets that the Chinese need, like foreign oil.
I think the Chinese eventually have to let their currency float, but doubt that they will move to a float in one step. Look for them to try an intermediate step like adjusting the yuan/dollar peg point in order to test the results first.
This statement - like most other fiscal & monetary policy statements - requires careful parsing.
1. The dollar peg hasn’t been in place “since 2008” - it has been in place for a lot longer. However, what has been in place since 2008 is a freeze to the gradual & controlled yuan appreciation, a 20% appreciation vs the dollar that started in 2005.
2. It is estimated that if the yuan were to float freely it would have another 20% to rise. A complete removal of any peg would certainly be a shock, but the Chinese have been managing yuan appreciation (the functional equivalent of deliberately lowering the value of thier dollar reserves) for years before the crisis.
3. The Chinese may indeed allow the RMB to increase, but are very unlikely to allow free float. They are fundamentally a mercantilist county - communist in name only. Mercantilist coutries focus on internal social stability and economic growth by promoting exports - in this day & age, undervalued currency is the main economic mechanism for doing that.
The problem I see is an absolute advantage scenario for Chinese goods in the US. The cost of goods imported will rise with no substitute American goods. America can not manufacture bluejeans, America can’t even manufacture ink needed to make the jeans blue. Maybe I’m being a little gloomy about the economics, I do not see any real comparative advantage. We sold our freedom long ago.