Renminbi Deflation

U.S. is running a huge deficit with China in recent years. China has held more than 1 trillion dollars of U.S. Treasury bonds. By owning U.S. debts, China is able to keep its Renminbi weaker than the dollar, which makes the U.S. imports from China cheaper and U.S. exports to China more expensive. By doing so, China is able to spur its domestic economy and keep its unemployment rate low. Therefore, the large number of U.S. imports and small number of U.S. exports result a large deficit in U.S. current account.

Another factor to look at the effect of the large reservation in the Renminbi to U.S. economy is to examine the effect of changes in the exchange rate to the variables in the NIA equation, which are consumption, investment, government purchases, and net exports. It is mentioned before that the Renminbi reservation causes a large deficit in the net export. Hence, with the appreciation of Renminbi, the price of U.S. imports from China will rise while the price of U.S. exports to China will decline. The increase in the price of Chinese imports will stimulate the U.S. economy and therefore decrease domestic unemployment rate. Meanwhile, as the NIA says, while the U.S. is running a deficit with China, there is also a capital flow from China to U.S., which means Chinese investors are investing in U.S. assets as well, allowing investment to occur in the states. Therefore, the appreciation of Renminbi will curb the foreign investment in the states. Moreover, as the Renminbi becomes more appreciated, the stronger U.S. economy will also be able to increase its government purchase in order to stimulate its economy further. As a result, the net effect of Renmimbi appreciation will be positive to U.S. economy, resulting in a decrease in unemployment rate and an increase in the domestic development.

In my view, the large reservation in the Renminbi enables China to keep its currency stability. While the Renminbi appreciation is beneficial to the U.S. economy, it will...