Log out Go to App
Go to App

Learning Materials

Features

Discover

Chapter 30: Problem 19

(Related to the Apply the Concept on page 1071 ) An article on usatoday.com included the following two observations: First, "Chinese companies and individuals have begun to invest more heavily outside the country." Second, "The yuan has dropped nearly 7 percent against the dollar so far this year. The Chinese government has responded by draining its foreign exchange reserves to buy yuan, hoping to slow the currency's fall." a. Is there a connection between Chinese companies and individuals investing more heavily outside the country and the drop in the yuan? Briefly explain. b. Why might the Chinese government want to slow the fall in the yuan? c. Why would the Chinese government have to drain its foreign exchange reserves to slow the fall in the yuan?

Short Answer

Expert verified
Chinese companies and individuals investing more heavily outside China can lead to a drop in the value of the yuan as they sell yuan to buy foreign currencies. The Chinese government may want to intervene to slow the fall of the yuan for economic stability and maintaining domestic and international trust. It uses its foreign exchange reserves to buy the yuan, thus bolstering its value.

Step by step solution

01

Connection between Investments and Currency Value

Yes, there is a connection. When Chinese companies and individuals invest more heavily outside the country, they may sell their yuan to buy foreign currencies to make these investments. This increase in the supply of yuan versus demand can result in a depreciation of the yuan against these currencies, thus causing a drop in its value.
02

Reason for Government Intervention

The Chinese government might want to slow the fall in the yuan to maintain economic stability and confidence domestically and internationally. A falling currency can lead to higher inflation as import goods become more expensive, which can erode consumer's purchasing power. It also can cause capital to flow out of the country, as investors move to stronger currencies, which could destabilize the financial system.
03

Why Draining Foreign Exchange Reserves?

The Chinese government would have to drain its foreign exchange reserves to buy up yuan and decrease its supply in the market. This action increases the demand for yuan, which in turn could help in slowing its fall. This is often seen as a last resort due to the goal of maintaining large foreign exchange reserves for financial stability.

Unlock Step-by-Step Solutions & Ace Your Exams!

  • Full Textbook Solutions

    Get detailed explanations and key concepts

  • Unlimited Al creation

    Al flashcards, explanations, exams and more...

  • Ads-free access

    To over 500 millions flashcards

  • Money-back guarantee

    We refund you if you fail your exam.

Start your free trial

Over 30 million students worldwide already upgrade their learning with Vaia!

One App. One Place for Learning.

All the tools & learning materials you need for study success - in one app.

Get started for free

Most popular questions from this chapter

(Related to the Apply the Concept on page 1067 ) An article in USA Today argued, "lronically, the euro's falland the benefit for German exports -is largely the result of eurozone policies that Germany has taken the lead in opposing ... [including] easier money policies by the European Central Bank." a. How does the "euro's fall" benefit German exports? b. How is the euro's fall related to policies of the European Central Bank?

How were exchange rates determined under the gold standard? How did the Bretton Woods system differ from the gold standard?

What does it mean when one currency is "pegged" against another currency? Why do countries peg their currencies? What problems can result from pegging?

An article in the Wall Street journal stated, "The years long battle that smaller European central banks (such as the central bank of Switzerland) have waged against their own strong currencies may have turned a corner, thanks to the strengthening euro." The article further noted that the "Swiss National Bank's foreign-exchange reserves accumulated on a massive scale since 2012 - dipped slightly last month." a. Why would the Swiss National Bank (the central bank of Switzerland) wage a battle against its own strong currency? b. Is there a connection between the Swiss National Bank waging a battle against its strong currency and the Swiss National Bank accumulating massive amounts of foreign exchange reserves? Briefly explain.

(Related to the Don't Let This Happen to You on page 1061 ) Briefly explain whether you agree with the following statement: "The Federal Reserve is limited in its ability to issue paper currency by the amount of gold the federal government has in Fort Knox. To issue more paper currency, the government first has to buy more gold."
See all solutions

What do you think about this solution?

We value your feedback to improve our textbook solutions.

Study anywhere. Anytime. Across all devices.

Sign-up for free