Recently there have been reports of China devaluating its currency against the U.S Dollar. I'm a layman and I am unable to understand the need for a country devaluating it's own currency. How would it help that country? Moreover newspapers report that this move by China could result in a currency war. So what exactly is a currency war? Please try to keep it simple, as I'm a layman in the field of economics.
Okay, in layman's words, devaluing yuan (against USD) means, Chinese made goods are cheaper in USD. On the other hand, American made goods are expensive in China as a result. China wants to keep its export competitiveness and may want to keep its 'world's factory' status. Well, South Korea may as well want to use a similar strategy to make domestically produced export goods competitive, similarly, other aisan governments considering devaluing their currencies. There would then be a currency war... hope this is as simple as you wanted to see.
To understand trade/currency conflict with China we have to look at a few of the major moving parts.
- Renminbi (RMB or yuan) is fixed to the dollar, the pair trade as one unit against all other currencies. So in global trade your currency is either fixed against a standard such as gold or floated freely against each other.
I am unable to understand the need for a country devaluating it's own currency. How would it help that country?
So as the dollar gains in strength, being that the yuan is pegged to the dollar as I just explained, it also gains in strength, which means that China has to devalue its own currency so it will not gain some much strength. Why is that a bad thing for China?
A much stronger USD would end up making Chinese goods more expensive everywhere on the globe except the United States. That said, a stronger or weaker dollar has no effect on the cost of Chinese goods in dollars as the yuan is pegged to the dollar.
The action of devaluing is then done in relation to the cost of dollars relative to Euros, Yen, etcetera.
In other words, what matters to China, is the dollars relative value to its other's trading partners currencies.
So when you hear that China is engaged in a currency war, its because people take China's devaluation of its own currency as a way to gain competitive advantage in affairs of trade.
So a currency war is known as a country devaluing its own currency to gain a trade advantage over another country. Many currency wars lead to this beggar-thy-neighbor situation of one nation remedying its own economic problems by worsening the economic problems of another nation.
So as a necromancer of Stack Exchange questions, answering a three year old post and anticipating someone commenting on that fact, its good to revisit and refresh the answer to these questions because it seems that our current administration here in the United States have seen the folly of beggar-thy-neighbor currency wars and have decided to strengthen instead of weakening the USD. Unfortunately, this is leading to a decline in the global competitiveness of China.
Keep in mind that, in effect, the United States exports credit to China and imports goods and dollars back. So the real issue to be observing in order to understand this complex topic is looking at the credit underlying the trade between U.S. and China.