Monday, October 25, 2010

[IWS] CRS: CHINA'S CURRENCY: AN ANALYSIS OF THE ECONOMIC ISSUES [1 October 2010]

IWS Documented News Service
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Institute for Workplace Studies----------------- Professor Samuel B. Bacharach
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Stuart Basefsky
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Congressional Research Service (CRS)

 

China’s Currency: An Analysis of the Economic Issues

Wayne M. Morrison, Specialist in Asian Trade and Finance

Marc Labonte, Specialist in Macroeconomic Policy

October 1, 2010

http://opencrs.com/document/RS21625/2010-10-01/download/1013/

[full-text, 37 pages]

 

Summary

Over the past several years, the Chinese government has maintained a policy of intervening in

currency markets to limit or halt the appreciation of its currency, the renminbi (RMB) against

other major currencies, especially the U.S. dollar. This policy appears to be largely intended to

keep China’s export industries competitive internationally and to attract foreign direct investment

(FDI), which have been major factors behind China’s rapid economic growth. Critics charge that

this policy constitutes a form of currency manipulation that is intended to make Chinese exports

cheaper, and imports into China more expensive, than they would be under a floating exchange

system. Some claim that China’s currency policy is a major cause of the large U.S. trade

imbalance with China and the loss of numerous U.S. jobs. Many Members of Congress have

urged the Obama Administration to designate China as a “currency manipulator” in order to

pressure it to let the RMB appreciate, and several bills have been introduced (including H.R.

2378, S. 1254, S. 1027, and S. 3134) which seek to address China’s currency policy. On

September 29, 2010, the House approved an amendment in the nature of a substitute to H.R. 2378

(by a vote of 348 to 79). The bill would attempt to apply U.S. countervailing laws to certain

fundamentally undervalued currencies.

 

From July 2005 to July 2008, the RMB was allowed to gradually appreciate against the dollar,

rising by about 21% over this period. However, once the effects of the global economic crisis

began to become apparent, China halted appreciation of the RMB to the dollar in an effort to limit

job losses in industries dependent on trade. From July 2008 to late June 2010, China kept the

exchange rate of the RMB at roughly 6.83 yuan (the base unit of the RMB) to the dollar. On June

19, 2010, the Chinese central bank stated that, based on current economic conditions, it had

decided to “proceed further with reform of the RMB exchange rate regime and to enhance the

RMB exchange rate flexibility.” Events following the announcement demonstrate that a flexible

RMB exchange rate could move both up and down over short periods of time. By September 23,

the RMB had appreciated by about 1.9% to 6.7 yuan. Many U.S. officials have criticized the slow

pace of RMB’s appreciation.

 

Many economists have argued that RMB appreciation is an important factor in helping to

rebalance the world economy. They have also urged China to implement policies to make

consumer demand, rather than exports and fixed investment, the main sources of economic

growth. Some see RMB appreciation as a way of boosting China’s imports, which could

contribute to a faster global economic recovery. While Chinese officials acknowledge the need to

rebalance the economy, they have strongly resisted international pressure to appreciate and

reform the currency, calling it “protectionism.” Some attribute this policy to concerns by the

Chinese government that implementing policy changes too rapidly could lead to social instability.

 

While the Obama Administration has pushed China to appreciate its currency, it has also

encouraged it to continue purchasing U.S. Treasury securities. China is the largest foreign holder

of U.S. Treasury securities, which totaled $847 billion as of July 2010. Some analysts contend

that, although an appreciation of China’s currency could help boost U.S. exports to China, it

could also lessen China’s need to buy U.S. Treasury securities, which could push up U.S. interest

rates. It could result in higher prices of Chinese-made goods for U.S. consumers, as well as for

Chinese-made inputs that U.S. firms use in their production. Many economists contend that, even

if China significantly appreciated its currency, the United States would still need to increase its

savings and reduce domestic demand (particularly the budget deficit), and China would have to

lower its savings and increase consumption, in order to reduce trade imbalances in the long run.

 

Contents

Introduction ...............................................................................................................................1

Historical Background on China’s Currency................................................................................2

2005: China Reforms the Peg......................................................................................................2

Recent RMB Developments ..................................................................................................4

Overview of the Debate Over China’s Currency Policy: U.S. and Chinese

Perspectives .......................................................................................................................5

Concerns in the United States: Trade Deficits and Jobs....................................................5

U.S. Legislative Proposals...............................................................................................9

China’s Perspective and Concerns: Economic Growth and Stability.....................................10

An Economic Analysis of the China Currency Issue ..................................................................12

Is the RMB Undervalued, and if so, by How Much?............................................................12

Why do Estimates of the RMB’s Undervaluation Differ so Much?.......................................13

The Debate over the Effects of Exchange Rate Appreciation on Trade Flows and the

Deficit.............................................................................................................................15

The Bilateral Trade Deficit Continued to Grow during the Previous Period of

RMB Appreciation.....................................................................................................15

The J Curve Effect ........................................................................................................16

The Role of Exchange Rate Pass-Through.....................................................................16

China’s Role in the Global Supply Chain.......................................................................17

Underlying Macroeconomic Imbalances Are Unlikely to Disappear ..............................17

Differing Opinions on Making RMB Appreciation a Top U.S. Trade Priority.................17

Winners and Losers of RMB Appreciation from an Economic Perspective...........................18

Effect on U.S Exporters and Import-Competitors...........................................................19

Effect on U.S. Consumers and Certain Producers ..........................................................19

Effect on U.S. Borrowers ..............................................................................................19

Net Effect on the U.S. Economy....................................................................................20

The Effects of an Undervalued RMB on China’s Economy..................................................21

Policy Options for the RMB and Potential Outcomes ................................................................23

Current Account Balances, Savings, and Investment............................................................26

Sources of Economic Growth..............................................................................................30

Investment and Consumption Relative to GDP..............................................................31

 

Figures

Figure 1. Nominal RMB/Dollar Exchange Rate: January 2008 to June 2010................................3

Figure 2. Change in China’s Real Trade Weighted Exchange Rate: July 2008-August

2010 .......................................................................................................................................4

Figure 3. The Yuan-Dollar Exchange Rate: June 18-October 1, 2010 ...........................................5

Figure 4. China’s Current Account Balance and Annual Change in Foreign Exchange

Reserves: 2001-2009................................................................................................................7

Figure 5. China’s Monthly Trade Flows: January 2008-July 2010..............................................12

Figure A-1. Chinese and U.S. Current Account Balances: 2000-2009 ........................................27

Figure A-2. Chinese and U.S. Current Account Balances as a Percent of GDP: 2000-2009 ........28

Figure A-3. Gross National Savings as a Percent of GDP for China and the United States:

1990-2009.............................................................................................................................29

Figure A-4. U.S. Real GDP Growth and Sources of GDP Growth: 2003-2009 ...........................30

Figure A-5. Chinese Real GDP Growth and Sources of GDP Growth.........................................31

Figure A-6. Gross Investment as a Percent of GDP for Selected Economies: 2008 .....................32

Figure A-7. Private Consumption as a Percent of GDP for Selected Economies: 2008................32

Figure A-8.Annual Growth in Real Chinese and U.S. Private Consumption: 2000-2009 ............33

Tables

Table A-1. Ratio of Gross National Savings to Gross Investment and Current Account

Balances as a Percent of GDP for Various Economies: 2008...................................................26

Appendixes

Appendix. Indicators of U.S. and Chinese Economic Imbalances...............................................25

Contacts

Author Contact Information ......................................................................................................33



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