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Tuesday, August 9, 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

China’s currency policy has been an issue of significant concern to many in Congress over the past several years. 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 is a deliberate Chinese policy to make its exports significantly cheaper, and its imports more expensive, than would if the RMB were a freely traded currency. They contend that the RMB is significantly undervalued against the dollar and that this has been a major contributor to the large annual U.S. trade deficits with China and the loss of U.S. manufacturing jobs in recent years. Some Members have urged the Obama Administration take a more aggressive stand against China over its currency policy, such as by designating it as a “currency manipulator” under U.S. trade law. Others have introduced legislation that would seek to counter the perceived effects of China’s currency policy on the U.S. economy. For example, in the 112th Congress, H.R. 639 and S. 328 would make a “fundamentally undervalued currency” an actionable subsidy under U.S. countervailing duty cases.

From July 2005 to July 2008, China’s central bank allowed the RMB to appreciate against the dollar by about 21%. However, once the effects of the global economic crisis became apparent, China halted appreciation of the RMB in an effort to help Chinese industries dependent on trade. From July 2008 to about mid-June 2010, China kept the exchange rate of the RMB relatively constant at 6.83 yuan (the base unit of the RMB) to the dollar. On June 19, 2010, the China’s central bank stated that it would resume appreciation of the RMB exchange. Since then, China has allowed the RMB/dollar exchange rate to rise by 5.4% (through the end of June 2011). Many U.S. officials have criticized this pace as being too slow, especially given China’s strong economic growth over the past few years, including its trade sector, and its rising level of foreign exchange reserves, which hit $3.2 trillion as of June 2011.

Many economists argue the that effects of China’s currency policy on the U.S. economy are mixed. If the RMB is undervalued (as many contend), then it might be viewed as an indirect export subsidy which artificially lowers the prices of Chinese products imported into the United States. This benefits U.S. consumers and U.S. firms that use Chinese-made parts and components, but could negatively affect certain U.S. import-sensitive firms. An undervalued RMB might also have the effect of limiting the level of U.S. exports to China than might occur under a floating exchange rate system. Further complicating the issue is China’s large purchases of U.S. Treasury securities, which totaled $1.2 trillion at the end of 2010. These purchases occur because China’s intervention in currency markets causes it to accumulate large levels of foreign exchange reserves, especially U.S. dollars, which are then used to purchase U.S. debt. Such purchases help the U.S. government fund the budget deficit, which helps to keep U.S. interest rates relatively low. These factors suggest that an appreciation of the RMB to the dollar could benefit some U.S. sectors, but negatively impact others. The effects of the global economic slowdown have refocused attention on the need to reduce global imbalances (e.g., savings, investment, and trade), especially in regards to China and the United States. Many economists contend that China should take steps to lessen its dependence on exports and fixed investment for its economic growth and instead rely more on domestic consumption. A market-based currency policy is seen as an important factor in achieving this goal. Further RMB appreciation could help promote the development of non-export industries in China, while boosting China’s imports, including from the United States. This report provides an economic analysis of China’s currency policy and lists current legislation and options for Congress.

Date of Report: July 14, 2011
Number of Pages: 42
Order Number: RS21625
Price: $29.95

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