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posted on 20 December 2015

Strong US Dollar Will Bring Deflation Pressure to China Economy

Written by , GEI Associate

Since mid 2014, the US dollar appreciated significantly against a breadbasket of currencies, and reached a decade peak in 2015. The strong US dollar weakened the competitive power of US products in world market with export falling by 4.3% in the first ten months of 2015. Trade deficits have widened due to the fall in US exports.

In order to strengthen financial stability, China let the Yuan peg to US dollar for a long time. Since mid 2014, compared with appreciation of over 20% to a lot of other currencies, US dollar appreciated against the RMB only 3%. Under expectation that Federal Reserve would raise rates in December, China economy may sustain a heavier deflation pressure as the slowing economic growth in China relies more on trade.

RMB appreciation directly results in further slowdown of China economy. In the third quarter of 2015, China GDP growth rate dropped to 6.9%, which is the worst performance since 2009. Weak manufacturing industry and exports offset strong impetus of service industry and consumption.

China is facing a dilemma. If it lets the RMB remain pegged with the appreciating US dollar, China economy has to sustain deflation pressure, particularly in manufacturing industry. However, devaluing the RMB against the dollar may also bring significant difficulties to domestic financial market due to dollar denominated debts held by Chinese enterprises, This will weaken debt paying ability and increase default risk.

Most economists predict China will further devalue the RMB. China is still in economic reform period, slower GDP and export growth rate can be expected, - but preventing the weakening of the domestic financial market is the most important factor that Chinese policy maker should worry about at this moment.

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