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Thursday, January 27, 2011

China’s Currency: An Analysis of the Economic Issues

Wayne M. Morrison
Specialist in Asian Trade and Finance

Marc Labonte
Specialist in Macroeconomic Policy

Since 1994, 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 the U.S. dollar and other currencies. Critics charge that this policy has made Chinese exports to the United States significantly cheaper, and U.S. exports to China much more expensive, than would occur under free market conditions. Some policymakers argue that China’s currency policy is a major factor behind the large annual U.S. trade deficits with China and has lead to the widespread loss of U.S. manufacturing jobs. Some economists have argued that China’s currency policy is disruptive to global economic recovery because it induces many countries to intervene in currency markets in an effort to hold down the value of their currencies against the dollar in order to enable their firms to remain competitive vis-à-vis Chinese firms. Some economists have expressed concern that these actions may worsen economic imbalances and could undermine the world trading system.

From July 2005 to July 2008, the central bank of China allowed the RMB to appreciate against the dollar by about 21%. However, once the effects of the global economic crisis began to become apparent, China halted appreciation of the RMB 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 China’s 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.” From June 18 to December 24, 2010, China allowed the RMB/dollar exchange rate to rise by about 2.9%% overall. U.S. officials have criticized the slow pace of RMB’s appreciation, especially given the rapid growth in Chinese exports and trade surplus over the past year, and have urged China to quicken the pace of currency reform and flexibility.

Many members of Congress have urged the Obama Administration take a more aggressive stand against China over its currency policy, including designating it as a “currency manipulator” under U.S. trade law. Several currency-related bills were introduced in the 111
th Congress. In September 2010, the House approved an amendment in the nature of a substitute to H.R. 2378, which would have attempted to treat certain fundamentally undervalued currencies as an actionable subsidy under U.S. countervailing duty (which could have resulted in higher tariffs on certain imported Chinese products). The Senate did not consider the bill. In addition to bilateral talks, the Obama Administration has sought to put more pressure on China by attempting to boost multilateral cooperation on addressing exchange rate policies and global trade imbalances.

Many economists contend that a sharp appreciation of the RMB would help to rebalance the global economy, but note that this must be accompanied by lower saving and greater consumption in China. An immediate and sharp appreciation of China’s currency could disrupt its export industries and lead to widespread lay-offs, which in turn could slow its economic growth and reduce import demand. However, if RMB appreciation occurred along with measures to boost domestic consumption, laid off Chinese workers in the export sector would be able to find jobs in other (non-export) sectors, which could help maintain healthy economic growth and boost Chinese demand for imports. While an appreciation of the against the dollar could help boost U.S. exports to China, it could also entail costs to the U.S. economy in the near term. China would not need to buy as many U.S. Treasury securities, which could cause real U.S. interest rates to rise. A more expensive RMB could also mean higher costs for U.S. consumers as well as firms that use Chinese-made inputs for their products. To reduce U.S. external imbalances (including with China), the United States would need to boost national saving.

Date of Report: January 12, 2011
Number of Pages: 38
Order Number: RS21625
Price: $29.95

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