Saturday, March 27, 2010

China's Yuan valuation : Undervalued?

Firstly, let us start off by looking at the big mac index. It is based on the theory of purchasing-power parity, which is basically showing how hard you need to work in order to make enough money to buy a Big Mac from MacDonald.

Below is a picture of the index, benched marked to the USD. An example, based on the picture, is that a person in Norway needs to work about 90% lesser than a person in the USA in order to buy a Big Mac.

According to the picture above, China's yuan is about 49% below that of the USD, based on this index.

However, will the USA actually benefit if China strengthen the Yuan? On first thought, it might. Because people will say that with a stronger Yuan, China's goods will be more expensive, hence they will export less to the USA.

But if you look closely, and for those of you who have been to the USA, most of the goods in the USA are actually 'Made in China'. With a stronger Yuan, companies in the USA will have to pay more to purchase their supplies from China, adding to their cost and thus lowering their profits.

An actual example that most of us can relate to is the Iphone. The actual cost of an Iphone is around USD300. The amount that goes to the workers in China who only assemble the parts is only USD 4. The rest of the money actually goes to the other countries that the parts are manufactured in.

So the conclusion is: Yes it is true, with a stronger Yuan, China's goods will be more expensive. However there will be negative repercussion on the USA's economy, whose supplies inevitability comes from China. With more expensive China goods, the USA will have to incur higher cost in their supplies. Thus either the USA companies will have to work with lower profit margins, or pass on the extra cost to their customers. Either way, I personally feel it is quite a lose-lose situation for the USA.


AK71 said...

The RMB is definitely undervalued. I have been buying some every month for more than a year now. :)

The Chinese govt will have to let the RMB appreciate. It is a matter of time. They have to address the problem of higher inflation and they don't really have a choice but to let the RMB appreciate.

ntuchartist said...

Yup, I agree that it is undervalue and will definitely have to appreciate soon.

But to me, it seems like the US is trying to accelerate it, which might actually have a negative impact on their economy..