The Chinese Currency Peg and its Effect on the US and the Chinese Economies

1
The Chinese Currency Peg and its Effect on the US
and the Chinese Economies

• Presented by
• Nathan Johnson
• Dimitar Minchev

2
Historical Overview

• Prior to 1994 China maintained a dual rate
  exchange system
• An official exchange rate of 5.8 yuan per dollar
• Market swap rate (used mainly for trade
  transactions) of about 8.7 yuan per dollar
• In 1994 the two rates were unified
• China pegt its currency to the US dollar form
  1994 to 2005 at a rate of 8.28 yuans to the
  dollar

3
Overview - Explanation

• What is a fixed exchange rate?
• Pegged, or fixed exchange rate is a rate the
  government (central bank) sets and maintains as
  the official exchange rate. A set price will be
  determined against a major world currency
  (usually the U.S. dollar, or a basket of
  currencies). In order to maintain the local
  exchange rate, the central bank buys and sells
  its own currency on the foreign exchange market
  in return for the currency to which it is pegged.

4
Overview - Explanation

• Chinas reasons for establishing fixed exchange
  rate
• Economic stability, respectively political
  stability
• Increased FDI flows
• Lower inflation
• Increased Exports
• Increased Demand

5
Economic Consequences of the Currency Peg

• Economic Consequences for China
• Annual GDP growth of 8.79 for the 94-05 period
  (more than 10 for the 03-07 period)
• Foreign reserves of 1.8 trillion in July of 2008
• Strong export industry
• Increased employment
• Troubled import industry

6
Economic Consequences of the Currency Peg

• Economic Consequences for the US
• Increased exports to China from 14,2 billion in
  98 to 65,2 billion in 2007
• Increased trade deficit from 56,9 billion in 98
  to 256,2 in 2007
• Increased level of foreign debt 10,6 trillion
• Loss of manufacturing jobs that compete directly
  with goods and services produced in China

7
Legislation

• U.S. Position
• Many in Congress have argued for more punitive
  legislation against China for their currency
  manipulation.
• The argument against China is that they are
  keeping their currency artificially low to gain a
  competitive advantage over the U.S.
• This represents a protectionist measure by China.
• China is hurting the U.S. manufacturing industry
  which cant compete with Chinas lower prices and
  is resulting in a loss of U.S. manufacturing jobs.

8
Legislation

• Chinas position
• They argue that the issue of Chinas trade
  surplus with the U.S. is unrelated to their
  exchange rate.
• Wages in China are so much lower in the U.S. that
  a revaluation of the yuan would have little
  impact on Chinas competitive advantage over the
  U.S.
• Chinas exports also have a large import
  component and so any revaluation of the yuan
  would also lower the input prices of its exports
  thus diminishing the impact of revaluation.
• China argues that the stability of its currency
  plays an important role in global financial
  stability.

9
Attempted Legislation

• The Fair Currency Enforcement Act of 2003
  sponsored by Joe Lieberman would
• Direct the President to begin immediately a
  90-day period of bilateral negotiations with
  those nations that are most egregiously engaged
  in currency manipulation to bring an end to it.
• Direct the International Trade Commission during
  those 90 days to gather facts and prepare the
  legal basis for action under existing provisions
  of the International Monetary Fund, the World
  Trade Organization, and various U.S. trade laws
  (including sections 301 and 406 of the Trade Act
  of 1974).
• Direct the President, in the event that bilateral
  negotiations fail, to institute formal
  proceedings in the appropriate national and
  international agencies as detailed by the ITC
  report or give the Congress detailed reasons why
  he declines to do this.
• Require the preparation of additional reports and
  recommendations from the Administration on the
  impact on our national security due to the loss
  of keys industries (such as semiconductor
  manufacture) due to currency manipulation more
  effective enforcement of existing trade laws and
  agreements and better utilization of government
  resources for trade promotion.
• This bill never became law

10
Other Legislation

• April of 2005 a bill was introduced in the Senate
  by Charles Schumer and Lindsey Graham that would
  impose a 27.5 on all imports from China unless
  they floated their currency or came close to it.
• The President could suspend the tariff during
  bilateral talks.
• China responded to this bill by allowing the yuan
  to appreciate 2.1 as well as committing to
  letting market forces play a stronger role in
  determining the value of the yuan.
• U.S. officials have stated that this bill has
  strengthened their position in bilateral talks
• However, since the initial appreciation of the
  yuan there has been little to no change in its
  value.
• Bilateral talks have failed to effect any change.

11
Other Legislation

• Trade Act of 1988
• Mandates a biannual report to Congress on foreign
  trade and currency manipulation.
• The U.S. Treasury must identify in this report
  countries that are purposefully manipulating
  their currency to gain a competitive advantage.
• Once a country has been labeled a currency
  manipulator by the Treasury, the U.S. initiates
  bilateral talks to end the offending practice.
• China was last tagged as a currency manipulator
  in 1994.
• In their most recent report in April of 2005 the
  Treasury stated that they have not found currency
  manipulation in China but concerns about exchange
  rates continue.
• The reason they did not label China a currency
  manipulator is because they did not meet all of
  the legal criteria as stated in the Trade Act of
  1988.
• The Treasury report stated that China was exempt
  in part because it did not have a material global
  current account surplus and had maintained a
  fixed exchange rate regime since 1994 through
  different economic conditions.
• The report still recommended the U.S. to engage
  in bilateral talks to move from its fixed
  exchange rate to a more flexible one.

12
Key Legislation

• The Trade Act of 1974
• Section 301 - The principal statutory authority
  under which the United States may impose trade
  sanctions against foreign countries that maintain
  acts, policies and practices that violate, or
  deny U.S. rights or benefits under, trade
  agreements, or are unjustifiable, unreasonable or
  discriminatory and burden or restrict U.S.
  commerce.
• Mandatory Retaliatory Action -  Where USTR
  determines that a foreign government is violating
  or denying U.S. rights or benefits under a trade
  agreement, or its acts, policies or practices are
  unjustifiable and burden or restrict U.S.
  commerce, Section 301 requires retaliation unless
  an exception applies.
• Discretionary Retaliatory Action - Where USTR
  determines that a particular act, policy or
  practice of a foreign country is unreasonable or
  discriminatory and burdens or restricts U.S.
  commerce, it has discretion as to whether to take
  retaliatory action.
• Scope of Authorized Retaliatory Action -   Where
  USTR makes an affirmative determination that an
  act, policy or practice is actionable under
  Section 301, it may suspend or withdraw trade
  concessions, impose duties or other import
  restrictions.

13
Key Legislation

• The Trade Act of 1974
• Section 406 Concerning trade with Communist
  countries.
• A Commission determines whether imports from a
  Communist country are causing market disruption
  in the United States.
• If the Commission finds market disruption, it
  then makes a remedy recommendation to the
  President.
• The President makes the final decision with
  respect to remedy.

14
Major Problems

• US export producers competing directly with
  Chinese producers are at a loss due to the
  cheaper labor cost in China. However, over the
  long run, the fixed exchange rate encourages
  trade (and investment) between the two countries
  by eliminating exchange rate risk. The reduced
  risk could make both imports and exports higher
  than under a floating system.

15
Major Problems

• US Consumers will also benefit in the long term.
  The undervalued yuan will increase their
  purchasing power. Since imports from China are
  not limited to the consumption goods, US
  producers will also import capital equipment and
  final products from China. An undervalued yuan
  lowers the price of these US products, while
  increasing their output.

16
Major Problems

• The effect on US borrowers can be seen in the US
  balance of payments accounts. Chinas central
  bank, citizens and corporations are heavily
  investing in US debt. This resulted in China
  becoming the biggest US debtor with 20,45 of the
  US foreign debt. At the same time, the increased
  capital investment lowers the US interest rates,
  and companies were able to make investments that
  were previously unprofitable.

17
Major Problems

• The net effect on the US Economy in the short-run
  is that output in the trade sector falls more
  quickly than the output of US recipients of
  Chinese capital rises, aggregate spending and
  employment will temporarily fall.
• However, free trade should be pursued because the
  gains from trade are large enough that the losers
  from trade can be compensated by the winners, and
  the winners will still be better off.

18
Major Problems

• The US government has experienced sustained
  pressure for years from the export manufacturing
  lobby to press China to let the yuan to
  appreciate. This was due to the loss of
  manufacturing jobs to China and was combined with
  the unprecedented levels of ever increasing trade
  deficit. The unresponsiveness and the aggressive
  stance of the Chinese government further
  increased tensions between countries until in
  July 2005 China began controlled appreciation of
  its currency.

19
Policy Issues

• The Yuan has appreciated more than 20 since
  Beijing removed the peg to the dollar in July of
  2005 under the threat of the Schumer/Graham
  legislation.
• Even so, Obama has indicated that he will
  challenge China on the issue of currency
  manipulation.
• He has called for China to rely less on exports
  and more in encouraging its domestic demand for
  growth.
• China wants the U.S. to lift its restrictions on
  high-tech exports saying this would help to level
  out the trade imbalance.

20
Policy Proposals

• Allow China to enact a gradual appreciation of
  its currency to reduce dollar-related inflation.
• Floating the yuan may further worsen global
  economic stability.
• Avoid falling into the trap of rising
  protectionism through sanctions under section
  301. Global trade is decreasing as a result of
  the financial crisis and it is important to
  maintain trading relationships.

21
Conclusion

• Questions?

22
References

1. http//www.freetrade.org/node/83
2. http//www.census.gov/foreign-trade/balance/c5700.
   html2007
3. http//afp.google.com/article/ALeqM5jV-Vqd3eFprUam
   ekQ_ctIU89Txyw
4. http//www.chinability.com/GDP.htm
5. http//www.treasurydirect.gov/NP/BPDLogin?applicat
   ionnp
6. http//en.wikipedia.org/wiki/United_States_public_
   debtcite_note-1

23
References-cont.

1. http//digital.library.unt.edu/govdocs/crs/permali
   nk/meta-crs-87391
2. http//www.treas.gov/press/releases/js774.htm
3. http//blog.mises.org/archives/008221.asp
4. http//www.pbs.org/newshour/bb/asia/china/pntr/
5. http//cbapp.csudh.edu/newsletter/052006/on_point.
   htm
6. Asia Times Online China News, China Business
   News, Taiwan and Hong Kong News and Business.

24
References-cont.

1. China Ends Fixed-Rate Currency 
2. China's currency peg is a gift to Europe The
   Japan Times Online
3. Floating And Fixed Exchange Rates
4. FTD - Congressional Highlights