China’s Undervalued Currency

Robert B. Cassidy Director of International Trade Collier Shannon Scott

Introducton

• China’s undervalued currency affects all countries including China – East Asia has maintained parity with the yuan since the Asia Financial Crisis • Creates global financial imbalances and distorts trade – U.S. current account deficit (EU as well) – Asia’s current account surplus

Yuan: Fixed Peg to the US$

• In 1994, China unified and depreciated its currency by 50% • During1994-2005, exchange rate virtually fixed at 8.28 Yuan to US$1 • July 2005, China appreciated currency to 8.11 Y/$ based on a basket of currencies.

• In practical terms, yuan is still pegged to the $ -- 1.2% appreciation since 7/05

Export Growth Strategy

• China’s and Asia’s undervalued currencies are a basic component of an export led growth strategy – Subsidize export – Subsidize foreign direct investment • Japan still restricts investment – Tax imports • Requires high savings rates to maintain

Table 1: General and Financial Indicators of the People's Republic of China (All figures are in billions of RMB or percent unless otherwise indicated) Main indicators 1997 1998 1999 Gross Domestic Product (GDP) Real GDP growth Consumer price index Urban per capita disposable income (RMB) Rural per capita net income (RMB) Unemployment rate* Financial indicators M0 supply % growth over previous year M1 supply % growth over previous year M2 supply % growth over previous year 7,897.3

9.3

2.8

5,160.3

2,090.1

1997 1,017.8

15.6

3,482.6

22.1

9,099.5

19.6

3.1

8,440.2

-0.8

5,425.1

2,162.0

1998 1,120.4

10.1

3,895.4

11.9

14.8

7.8

3.1

10,449.9

8,967.7

-1.4

7.6

5,854.0

2,210.3

1999 3.1

1,345.6

20.1

4,583.7

17.7

11,989.8

14.7

9,921.5

8.4

0.4

8.9

2000 6,280.0

2,253.4

3.1

2000 1,465.3

5,314.7

16 13,461.0

12.3

2001 10,965.5

8.3

0.7

6,859.6

2,366.4

2001 3.6

1,568.9

7.1

5,987.2

12.7

15,830.2

17.6

12,033.3

9.1

-0.8

7,702.8

2,475.6

2002 1,727.8

10.1

7,088.2

16.8

2002 4 18,500.7

16.8

2003 13,582.3

10 1.2

8,472.2

2,622.2

2003 4.3

1,974.6

14.3

8,411.9

18.7

22,122.3

19.6

Exchange rate (RMB/$) Foreign exchange reserves (US$ billion) Government deficit Domestic debt 8.0

139.9

58.2

247.7

8.28

145.0

92.2

331.1

8.28

154.7

174.4

371.5

8.28

165.6

249.1

418.0

8.28

212.2

251.7

460.4

8.28

286.4

567.9

315 8.28

403.3

293.5

615.4

Foreign debt ($ billion) 12.6

146.0

151.8

145.7

170.1

171.4

1936.3

Sources: PRC National Bureau of Statistics (NBS), China Statistical Yearbook, 2004; The People's Bank of China Notes:*According to official SSB figures, which do not include underemployment or the migrant population, NA = not available 2004 15,987.8

10.1

3.9

9,421.60

2,936.40

4.2

2004 8.7

2,146.8

9,597.1

13.6

25,321.0

14.6

8.28

609.9

209.0

687.9

228.6

2005 18,282.0

9.9

1.8

10,493.00

3,255.00

4.2

2005 2,403.2

11.9

10,727.9

11.8

29,876.0

18 8.07

819.0

NA NA NA

Copyright 2006 by the US-China Business Council. All rights reserved.

Rising Chinese Surpluses

1200

China's Indexed Foreign Exchange Reserves and China's Indexed Surplus with the U.S., Annually 1995-2005

1000 800 600 400 Indexed Surplus Indexed FER 200 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Prepared by Georget own Economic Services

Year SOU R C E:

Of f icial St at istics of t he U.S. Depart ment of Commerce, IM F Int ernat ional Financial St at istics

Table 1: Foreign Investment in China, Jan.-Nov. 2004 Note: Percentages may not add up because some categories were omitted from this table.

Sources: Ministry of Commerce and the USCBC Investment Vehicle Number of Contracts Amount Contracted Amount Utilized Total % Change % of Total $ Billion % Change % of Total $ Billion % Change % of Total Foreign Direct Investment (FDI) 43,664 Equity Joint Ventures Contractual Joint Ventures Wholly Foreign-Owned Enterprises 11,570 1,343 30,708 6.29

-7.60 -13.19

13.97

100.0

26.50

3.08

153.47

27.64 7.79

70.33

117.28

33.38

8.37

4.13

43.70

100.00

18.01

5.08

76.42

60.63

16.39

3.11

40.22

13.32

6.46 -18.88

20.49

100.00

27.03

5.12

66.34

43 16.22

0.10

0.77

99.09

0.50

0.77

136.68

1.27

Share-based Enterprises with Foreign Investment Cooperative Development 0 -100.00

0 0 -100.00

0 0.11

226.45

0.18

Enormous Increase in FDI

Foreign Direct Investment in China

160 150 140 130 60 50 40 30 20 10 0 120 110 100 90 80 70 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Year

Prepared by Georget own Economic Services

Total FDI Contracted Total Utilized FDI US Share of Total Utilized FDI* US Share of Total FDI Contracted* * Estimat ed f or 2004 Source: China M inistry of Commerce

Chinese Trade Data Incorrect

China’s Global Trade Surplus (Exports-Imports), Adjusted for Hong Kong Re-Export Trade, 1999 – 2005 YTD

By Source, in Billions of US$

Year

1999 2000 2001 2002 2003 2004 2004 (Jan-Mar) 2005 (Jan-Mar)

China Data

$27.8

$30.4

$26.0

$31.5

$29.7

$45.8

($3.1) $21.0

Partner Data

$118.6

$147.6

$151.2

$174.3

$201.8

$278.6

$51.5

$81.0

Prepared by Georgetown Economic Services

Understatement $90.8

$117.2

$125.3

$142.8

$172.1

$232.8

$54.6

$60.0

Chinese Trade Data Incorrect

Comparison of China-Reported Data with Trading Partner Data 2004 Bilateral Trade Surplus(+)/Deficit(-) Million U.S. Dollars Country

Canada Japan European Union (15) United States

China Data

$1,187 ($15,946) $35,232 $84,674

Partner Data

$13,512 $15,752 $81,914 $163,553

Understatement $12,325 $31,698 $46,682 $78,879

Prepared by Georgetown Economic Services

Effects of Undervalued Yuan

• Chinese exports subsidized; imports taxed • Investment is cheap • Foreign exchange (F/X) increases • Money supply increases • Inflation increases • Free floating currencies bear the burden of adjustment: euro, Pound, C$

Is the Yuan Properly Valued?

• •

Consensus that the Yuan is undervalued

– – –

International Organizations (IMF) Administration Statements (Bush, Snow, others) Scholarly Research: including CRS Only Dispute: Degree of undervaluation

– – –

10%-75%, depending on data on exports/imports Treasury and IMF: use Chinese data CCC, others use trading partner data: reverse engineering

Estimates of Undervaluation

Source Publication Date Percent Undervalued World Bank Big Mac Index Preeg Yang and Bajeux Besnainou Williamson Anderson/UBS Goldstein O’Neill & Wilson Bhalla PPP Level The Economist MAPI Is the Chinese Currency Undervalued?

IIE lecture The Complete RMB Handbook Testimony to Congress Goldman Sachs Rpt.

Chinese Mercantilism: Currency Wars and How the East Was Lost 2000 Apr. 2003 Sept. 2002 Nov. 2003 Oct. 2003 Oct. 2003 Oct. 2003 Sept. 2003 July 1998 75% 56% 40% 27.99% based on PPP (using 1985 as fixed base year) Over 25% Nearly 25% in real terms 15-25% 10-15% 10-15% as of 1998

What Do We Do

• Three approaches: – Jawboning: Treasury approach up to now • Yuan appreciates by 2.1% in July and further 1.2% since then – IMF Pressure: IMF sets up medium-term review of global imbalances • All countries’ measures put on the table – Domestic Legislation

Progress to Date

4.9

5.2

5.5

5.8

6.1

6.4

6.7

7 7.3

7.6

7.9

8.2

8.5

Chart 1: U.S. Dollar Exchange Rate for the Yuan

Daily, July 18th, 2005 - Present Ju l. 18 Au g.

1 Au g.

1 Au 5 g.

2 Se 9 p.

1 Se 3 p.

2 O 7 ct . 1 O 2 ct . 2 N 6 ov . 9 N ov . 2 D 5 ec . 9 D ec . 2 Ja 3 n.

1 Ja 0 n.

2 Fe 5 b.

8 Fe b.

2 M 3 ar . 9 M ar . 2 Ap 3 r. 6 Ap r. 20 Yuan Revalued

40 Percent Appreciation

Hypothetical Yuan per US$* Actual Yuan per US$

X/R for Asian Currencies

Chart 2: U.S. Dollar Exchange Rates for Various Asian Currencies

Daily, July 18th, 2005 - Present 91 93 95 97 99 101 103 105 107 109 Ju l. 18 Au g.

1 Au g.

1 5 Au g.

2 9 Se p.

1 3 Se p.

2 O 7 ct . 1 O 2 ct . 2 6 N ov . 9 N ov . 2 D 5 ec . 9 D ec . 2 3 Ja n.

1 0 Ja n.

2 5 Fe b.

8 Fe b.

2 M 3 ar . 9 M ar . 2 3 Ap r. 6 Ap r. 20 Yuan Revalued China Japan Malaysia South Korea

Legislative Approaches

1. Broad monetary approach: Grassley/Baucus legislation 2. Broad trade approach: Schumer/Graham legislation 3. Trade remedy approach: – House: Thomas/English; Hunter/Ryan – Senate: Collins

Latest Legislation

• Grassley/Baucus (S-2467): Currency Manipulation – Fundamental Misalignment: Deletes intent • Disparity between observed levels and rate consistent with underlying economic fundamentals • Consultations with government and IMF • Failure of government to consult: – Deny OPIC Investment (Mainly China) – Deny World Bank loans (Mainly China) – Deny Increased voting share in IMF (Mainly Japan) – No provision on CVD cases against China

Broad Trade Approach

• Senators Schumer/Graham (S-295) – Impose Tariffs of 27.5% – Would take 2 years to impose tariffs – Held off vote until after President Hu’s visit. – WTO inconsistent – Likelihood of passage: slim

Trade Remedy Approach

• Senator Collins and Rep English/Thomas – Allow CVD investigations • Does not define undervalued currency as prohibited export subsidy – Thomas/English passed the house – New bill by Senator Collins (S-1421) tracts the Thomas Bill • Minor problems regarding double counting

Trade Remedy Approach

• Rep Hunter/Ryan (HR 1498) – Allows CVD investigations; defines currency manipulation as prohibited export subsidy – Currency manipulation also a factor in section 421 safeguard actions – WTO compliant • Advantages: – Targets remedies to industries that are hurt – Targets undervalued currencies.

Conclusion

• HR 1498: Only legislation that provides relief to injured companies – Only legislation that will get China’s attention • Thomas, Collins: Permits CVD cases but doesn’t focus on currency undervaluation • Grassley: Uses existing mechanisms of Treasury reports and IMF actions; no remedies for specific industries.