Undervalued or Not, the Yuan is Not Likely to Gain Much

Filed in archive Yuan Renminbi on June 29, 2009

I came across a couple of articles recently the seemed to complement each other on the relative value of the U.S. dollar and the China's Yuan Renminbi.

Nikhil Raheja has an excellent explanation of the theory behind exchange rate.

The currency exchange rates of every country in the world are based on a concept called the Purchasing Power Parity (PPP). This concept says that a currency's value is based upon the total number of products that can be bought with a single unit of that currency. So if USD$1 buys two McDonald's apple pies in the US, while RMB1 (Chinese Renminbi) buys only one McDonald's apple pie in China, then the exchange rate between the US and China would be RMB 2 = USD$1, since an American would then be able to exchange his US dollars for Chinese RMB in China and be able to buy the same number of pies there as he would have in the US.

Is that simplistic? Of course. Because the theory is simplistic. Raheja makes it pretty clear that life is more complicated that theory...

Michael Pettis asks a simple question about the exchange rate between the two countries: Can the RMB Be More Undervalued Today than It Was Last Year? While the question sounds rhetorical, he goes on to place a number on the undervaluation, saying the Yuan is about 40% undervalued. So the answer is yes. After all, mathematically speaking, it could be 50% undervalued.

Lest we get out of touch with reality, Seeking Alpha gives us a research recap to consider and draws the conclusion that the Yuan is not likely to appreciate much in the near future, regardless of whether it is undervalued or not. Keeping is touch with reality is important if you're going to make good policy and good financial decisions.


© upton