By Robert R. Ebert, Ph.D., Buckhorn Professor of Economics
Robert R. Ebert, Ph.D., is Professor of Economics and holder of the Buckhorn Chair in Economics. A 1965 graduate of B-W, Professor Ebert received his M.A. and Ph.D. from Case Western Reserve University. His specialties include international economics, industrial economics and microeconomics. He has published two books and more than 25 articles on the international and domestic motor vehicle industry and the pipe organ industry.
At first glance, the monetary dispute between China and the United States should have a simple solution. If the Chinese Yuan is undervalued, it should be allowed to float upward against the dollar in a free market. In such an event, as shown in the table below, Chinese goods become more expensive in the U.S. and U.S. goods become cheaper in China. U.S. exports to China would increase and imports from China would decrease, thereby narrowing the United States’ trade deficit with China.
Case closed. Right?
Well, not exactly, because the world of political economy has made the U.S.-China currency dispute far more complex.
The Trade Setting
Trade between the U.S. and China has burgeoned in recent decades. As shown in the chart on page four, using data on international trade from the U.S. Census Bureau, the value of bilateral trade between the two countries exceeds $180 billion per year. The chart also shows that U.S. exports to China have been growing steadily, but have been outpaced by the growth in imports. Thus, the U.S. trade deficit with China, which was $103 billion in 2002, reached $124 billion in 2003.
In the last quarter of 2003, as reported by the Wall Street Journal, trade tensions erupted between the U.S. and China in at least three areas:
1) The World Trade Organization (WTO) ruled that the U.S. violated global trade rules by raising tariffs on imported steel by as much as 30%. China warned it would retaliate by imposing tariffs on unspecified U.S. products if the U.S. did not abide by the WTO ruling (Wonacott).
2) The U.S. announced it would limit growth in China’s exports of bras, bathrobes, and knitwear to the U.S.; China said it might appeal to the WTO and postponed a trip to the U.S. by 30 Chinese officials to buy U.S. agricultural products (Wonacott).
3) In response to an antidumping complaint by Five Rivers Electronic Innovations LLS of Greenville, Tennessee (which makes TVs under a variety of brand names including Zenith and Samsung), the Commerce Department imposed duties of as much as 46% on imported Chinese color TVs. China’s Ministry of Commerce stated the tariffs showed “a severe discrimination against Chinese manufacturers” and could rattle “the normal trading orders between China and the U.S.” (Wonacott and King).
The Exchange Rate Issue
Reference to the Chinese currency is sometimes made in yuan (CNY) and at other times as Renminbi (RMB). Technically, the currency is the Renminbi, which literally means “people’s currency,” and the unit of account is the yuan.
The value of the yuan has been pegged at about CNY 8.28 to $1.00 since 1997. Given the large trade imbalance between the U.S. and China, the U.S. argues that the RMB should be revalued upward by as much as 35% (Goldstein and Lardy). One might argue that by defending the peg of its currency, China is engaging in what amounts to exchange rate or monetary protectionism, using an artificially low exchange rate to inhibit the growth of imports and encourage exports.
The Chinese, for their part, argue that a stable RMB is essential to maintaining Asian economic stability. In fact, during the Asian financial crisis of the late 1990s, China steadfastly defended the RMB at the peg and was widely applauded for doing so because it was believed to have prevented a round of competitive currency devaluations in Asia. That defense was not without cost, however. For example, Ivan Roberts of the Reserve Bank of Australia and Rod Tyers of Australia National University say research suggests that had China depreciated the RMB during the crisis, it could have prevented losses of about 4% of GDP (Roberts and Tyers, 157).
During the late summer and early fall of 2003, U.S. Treasury Secretary John W. Snow put considerable pressure on China to permit the RMB to float on currency markets and rise against the dollar. Even President George W. Bush, in a meeting with Chinese President Hu Jintao prior to the APEC summit in October, urged China to let its currency submit to market forces. The suggestions were rejected by the Chinese leadership (Day, A12).
What Is Appropriate Policy?
Political pressure on the Bush Administration over the value of the Chinese currency is extensive. Secretary Snow delivered a report to the Senate Banking Committee on October 30, 2003 in which he appeared to be more conciliatory toward China by saying it is not manipulating its exchange rate. He stated that financial diplomacy was “the surest course to get the result we want.” (Andrews).
Both Democratic and Republican members of the Senate complained that the Bush administration was painting too rosy a picture of the situation. The same New York Times article reported that several Senators, including Republicans, were pushing for legislation that would impose stiff tariffs on Chinese imports that would compensate for the amount its currency was deemed to be undervalued (Andrews).
There also is academic support for revaluation of the RMB. In the Asian Economic Journal article cited, Roberts and Tyers argue that China’s capital markets are becoming globally integrated and regional conditions have stabilized. They continue by saying that in such an environment, maintaining the RMB-dollar peg erodes the independence of Chinese monetary policy and risks the danger of a speculative attack on the currency if domestic or regional conditions would weaken (Roberts and Tyers, 180).
However, Zhou Xiaochuan, governor of China’s Central Bank, the People’s Bank, argues it is too early to conclude whether the RMB is undervalued or overvalued and that it would be unwise to make adjustments based on such assumptions. He also has indicated the market will play a bigger role in setting the exchange rate in the future, but that eventuality is still in the future. Supporting Zhou’s position have been two World Bank Economists, Deepak Bhattasali and Dominique Mensbrugghe, who agree with the Chinese government that the exchange rate liberalization should proceed slowly and only after other economic adjustments related to China’s accession to the WTO are resolved (People’s Daily). As this article goes to press in late February 2004, the media have advanced rumors that the Chinese government may be considering revaluation of the RMB, but would likely do it gradually, in stages.
Much of the debate over the pegged value of the RMB has centered around the trade imbalance between the U.S. and Chinese. However, currency values are a function of both trade and capital flows. While China has a significant surplus in Foreign Direct Investment (FDI) that amounts to 4% of GDP, the overall capital flow surplus is only 1% of GDP. When China finally liberalizes all capital flows, it is possible that a desire of Chinese investors (who have household savings equivalent to 100% of GDP) to diversify their holdings would lead to investment abroad, a capital outflow, and downward pressure on the RMB (Goldstein and Lardy).
From the perspective of the U.S., with an economic expansion just recently showing robust tendencies, pressuring the Chinese to revalue the RMB is an attractive political and, at least short-term, economic policy - especially in a presidential election year in which trade is likely to be an important issue. However, there are no free lunches in economic affairs. If the RMB is revalued upward, which means the dollar depreciates against the RMB, there could be long-term economic consequences at home. A depreciated dollar will mean higher prices for goods from China for which Americans have developed a rather healthy appetite. Rising prices increase the possibility of inflation, which brings with it another set of problems, a discussion of which goes beyond the scope of this article.
Perhaps, in the best of all possible worlds the RMB would have been allowed to float after the immediate problems of the Asian financial crisis abated. But, we do not live in the best of all possible worlds and must adjust U.S. policies to global economic realities. Therefore, it may be appropriate that Secretary Snow has backed off somewhat from an adamant stance on the value of the RMB. It would be a major miscalculation, if - as a result of pushing the issue too aggressively - we fell under the curse of getting what we asked for, and in the process unleashed a whole new set of problems. There just might be something to that concept of financial diplomacy after all. v
Works Cited
Wonacott, Peter. “China Threatens U.S. With Tariffs In Trade Dispute.” November 21, 2003. The Wall Street Journal. http://online.wsj.com/article_print/0,,SB106932867094105100,00.html, November 26, 2003.
Wonacott, Peter and Neil King, Jr. “U.S., China Risk New Trade Sport Over Color TVs. November 25, 2003. The Wall Street Journal. http://online.wsj.com/article_print/0,,SB106974111659207800,00.html, November 26, 2003.
U.S. Bureau of the Census. “U.S. Trade Balance with China.” http://www.census.gov/foreign-trade/balance/c5700.html, November 12, 2003 and February 15, 2004.
Goldstein, Morris and Nicholas Lardy. “A Modest Proposal for China’s Renminbi.” August 26, 2003. Financial Times http://www.iie.com/publications/papers/goldstein0803.html, November 26, 2003.
Roberts, Ivan and Rod Tyers. “China’s Exchange Rate Policy: The Case for Greater Flexibility.” Asian Economic Journal 2003 Vol.17, No.2, pp155-184.
Day, Phillip. “The Lone Fight to boost the Yuan.” October 21, 2003. The Wall Street Journal, pp. A11-A12.
Andrews, Edmond L. “Treasury Loosens Pressure on China Over Exchange Rate.” October 31, 2003. New York Times. http://query.nytimes.com/gst/abstract.html?res=F30614F93E540C728FDD A90994DB404482
“World Bank Official Backs RMB Policy.” People’s Daily Online. http://english.peopledaily.com.cn/200309/07/print20030907_123890.html, November 12, 2003.
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