Like other countries, China supports pegs of its currency to other important currencies. China devalues the RMB by moving the peg. It did this last summer:
The effect of devaluation depends on whether it is an adjustment toward or away from the currency’s underlying purchasing power. If the devaluation is moving the currency in line with its purchasing power, then it improves the efficiency of the international division of labor. If the devaluation is moving the currency below its purchasing power, then it leads to a less-efficient international division of labor.
A devaluation means that a given amount of foreign currency will buy more of the devalued Chinese currency and therefore, the foreign currency price of Chinese exports is reduced (because the price of the exported products in the Chinese currency remains unchanged). But, again, whether is is beneficial or harmful to the international economy depends on whether the devaluation brings the currency in line with its purchasing power or pushes it below its purchasing power.
If the devaluation brings the Chinese currency in line with its purchasing power, then efficiency is improved and worldwide standards of living rise. (The Chinese products were over-priced to Americans and under-priced to the Chinese before the devaluation.) If America then places a tariff on goods imported from China after the devaluation corrects the inefficiency, the international division of labor is less efficient.
If the devaluation pushes the Chinese currency below its purchasing power, then the international division of labor is made less efficient and standards of living are lower than otherwise. If America then places a tariff on goods imported from China, the American government receives tax revenue paid from the lowered income of Chinese producers. Therefore, these two policies, the Chinese devaluation and the American tariffs, do not cancel out and render the efficient result of the free market.
China’s prosperity depends on it continuing to move toward a free market economy. Unilateral rollback of government intervention on all fronts and unilateral strengthening of the legal sanction of private property and contract is called for.
As long as the Chinese continue to save, the world’s credit markets will not change and therefore interest rates across the world will not change. Capital markets across the world are integrated. Only is the Chinese quit saving and start consuming will interest rates rise and then not only in America, but everywhere.
Here’s is something to read on international trade theory: