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The simple answer is that the Chinese Renmimbi would rise in value against the US dollar, and therefore the US dollar would fall in value against the Renmimbi, firstly because of its massive trade surplus and secondly because of the continuing influx of investment capital to China. However, China buys large amounts of US currency in order to stabilise the value of its currency. By floating the Renmimbi, China would no longer need to do this, cutting off a major source of funding for America's current account deficit. While the United States continues to run a massive current account deficit, one impact of the withdrawal of Chinese funds would be a loss of liquidity in the US economy. As a result, America could either go into recession or print money for domestic circulation, with inflationary consequences.

Another impact, if China immediately ceased US currency purchases, is that the US currency would probably go into free-fall against all other currencies, as the market attempted to find a value at which the US currency would not require Chinese support. The consequences of such a major disruption to the market would be catastrophic. It is important for US financial markets and the US economy generally, that China gradually frees up its currency, allowing the US currency to adapt, and that the United States reduces its trade deficit against the rest of the world.

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Q: What would happen to US financial markets if China floated its currency?
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