China’s Currency Manipulation and Legislative Initiatives

Robert B. Cassidy Director International Trade and Services

The Important Questions

• Does China manipulate its currency?

• Is the Yuan undervalued?

• Does it’s undervalued currency hurt the United States?

• Does China’s manipulation help China?

• What do the various legislative initiatives do to correct the problem?

#1: Does China Manipulate the Exchange Rate for the Yuan

• 1994: China unified its dual exchange rate and depreciated it by 50% • China has fixed its exchange rate at 8.28 yuan/dollar since 1995 • Exporters exchange dollars for yuan from the SAFE and at no other exchange rate.

#1: Does China Manipulate the Exchange Rate for the Yuan

• Fixed exchange rate does not violate WTO or IMF rules • Violates WTO rules when exchange rate frustrates the intent of the WTO agreements. • Violates IMF rules when a country manipulates its exchange rate to gain an unfair competitive advantage.

#2 Is the Yuan undervalued?

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

Chinese Trade Data Incorrect

China’s Global Trade Surplus (Exports-Imports), Adjusted for Hong Kong Re-Export Trade, 1999 – 2004 YTD By Source, in billions of US$ Year

1999 2000 2001 2002 2003 2003 (Jan-June) 2004 (Jan-June)

China Data

$28.0

$30.7

$26.2

$31.8

$29.9

$8.3

$2.5

Partner Data

$118.8

$147.9

$151.5

$174.6

$202.0

$49.9

$63.2

Prepared by Georgetown Economic Services

Percent Divergence

325% 382% 479% 450% 575% 504% 2411%

Chinese Trade Data Incorrect

Comparison of China-Reported Data with Trading Partner Data 2003 Bilateral Trade Surplus(+)/Deficit(-) Million U.S. Dollars Country

Canada Japan European Union (15) United States

China Data

$1,477 -$11,040 $21,616 $60,321

Partner Data

$9,919 $14,326 $57,783 $124,913

Percent Divergence

-85% -177% -63% -52%

Prepared by Georgetown Economic Services

#2 Is the Yuan Undervalued

• NAM has argued that Yuan is undervalued by 40% • Undervalued currency is an export subsidy and a surtax on U.S. exports • Since Asian financial crisis, other Asian countries have pegged their exchange rates to the yuan/dollar.

• China is the most egregious but an overall Asian problem

#3 Does the undervalued yuan hurt the United States?

China's Indexed Foreign Exchange Reserves and China's Indexed Surplus with the U.S., Annually 1995-2004

900 800 700 600 500 400 300 200 100 0 1995 1996 1997 1998 1999

Prepared by Georget own Economic Services

2000 2001 2002 2003 2004

Year

Indexed Surplus Indexed FER

SO U R C E:

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

#3 Does the undervalued yuan hurt the United States?

• Trade deficit for 2004 was 162 billion, highest bilateral trade deficit – Undervalued currency a tax on U.S exports – A subsidy on Chinese exports to the U.S.

• Foreign exchange reserves over $600 billion, 80% held in U.S. dollar reserves – Foreign investment is cheap in China – Speculative flows increasing as rumors spread

#3 Does the undervalued yuan hurt the United States?

• NAM estimates that U.S. manufacturing has suffered –

60% of imports from China displace U.S. production; 40% at expense of other suppliers

– –

Price pressure on domestic suppliers Manufacturing jobs declined by 2.8 mil since 2001

#4 Does manipulation help China?

Foreign Direct Investment in China

160 150 140 130 120 110 100 90 80 70 60 50 40 30 20 10 0 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* * Est imat ed f or 2004 Source: China M inist ry of Commerce

#4 Does China’s Exchange Rate Manipulation Help China?

• Foreign direct investment in China exceed $60 billion, second only to US • Economy growing at 9.5% • China needs to create 15-25 million jobs • Hurts China in long run: – Overheated economy – Inflation increases

Table 1: China's Economic Indicators, 2000-04 Source: PRC National Bureau of Statistics (NBS, www.stats.gov.cn

) China Statistical Yearbook, 2003 Notes: *Of enterprises with sales of more than RMB 5 million; **According to official NBS figures, which do not include under-employment or the migrant population 2000 2001 2002 2003 2004 GDP (RMB billion) Real GDP growth (%) 8,946.8

8.0

9,731.5

7.5

10,517.2

8.3

11,725.2

9.3

13,651.5

9.5

Fixed-asset investment Value-added industrial output* Retail sales Consumer price index (%) 10.3

17.8

9.7

0.4

13.0

11.6

10.1

0.7

16.9

16.5

11.8

-0.8

27.7

27.3

9.1

1.2

25.8

16.7

13.3 3.9

Urban disposable per capita income (RMB) Rural net per capita income (RMB) Urban unemployment rate (%)** 6,280.0

2,253.4

3.1

6,859.6

2,366.4

3.6

7,702.8

2,475.6

4.0

8,472.2

2,022.2

4.3

9,422 2,936 4.3

#5 What is Congress Doing?

• Schumer/Graham (S. 295): Authorizes negotiations on currency and if not successful, apply 27.5 % import duty • Stabenow (S. 14): Apply 27.5% import duty if China doesn’t revalue yuan • Collins/Bayh (S. 593): Provisions on countervailing duties apply to non-market economy countries (e.g., China) • Lieberman: Requires negotiation and appropriate action against currency manipulation

#5 What is Congress Doing?

• Sanders (H.R. 728): Withdraw normal trade relations treatment.

• English (H.R.1216): Apply countervailing duties against non-market economy countries (e.g., China) • Ryan/Hunter (H.R. 1498):Exchange rate manipulation subject to countervailing duties and China safeguard actions

Legislation Schumer/Stabenow Lieberman Sanders Collins/English Ryan/Hunter Pros Comprehensive; applies 27.5% duty across the board Comprehensive: negotiation and “appropriate” action Comprehensive: withdraws MFN, but doesn’t address what tariff will be Applies countervailing duties (CVD) against subsidies Treats China like other WTO members

WTO legal

Applies CVD against subsidies; defines currency manipulation as prohibited export subsidy Treats China like other WTO members Currency manipulation a “consideration” in 421 safeguard case Prohibits government procurement when market disruption exists

WTO legal

Cons

WTO illegal

– violates Article 1&2 – MFN and bound concessions No definition of “appropriate”

WTO Illegal

: WTO requires unconditional MFN treatment (Article 1) Product-by-product (pro and con) Injury test Doesn’t specifically address currency manipulation: Commerce would have to make determination Product-by-product (pro and con) Injury test

Status of Legislation

• Schumer’s bill will be voted on by August • Bayh/Collins will have hearing in Finance Committee • Ryan/Hunter has 60+ co-sponsors – Because of defense provisions, has dual oversight • English has 34 co-sponsors; referred to Ways and Means Committee

Exchange Rate Scenarios

• IMF proposal: – Move to more flexible exchange rate (appreciation) – Drop hard peg; move to basket of currencies – Broaden the band from the current 1% • Treasury: adopt floating exchange rate – Capital markets still closed and weak – Danger that currency will depreciate • CCC: Appreciate by 40% but maintain peg – Basket and broader band acceptable but not priority

Possible Revaluation Scenarios

• Market predicting small appreciation (5 8%), a wider band (only 1% currently); and based on a basket of currencies.

– May be too modest to result in significant adjustment

What’s next?

• Pressure mounting on euro and other market determined currencies • U.S. under pressure to reduce twin deficits.

• Imbalances becoming more extreme • Search for a soft landing: – Pressure on China to realign – Multilateral accord similar to Plaza Accord

Lessons learned

• China does not move unless forced to move – China understands and respects power – Failure to use it; lose it • China will threaten and bluster • Important to stand firm and defend U.S. interests.

Robert B. Cassidy

Collier Shannon Scott 3050 K St. NW Washington DC 20007 202-342-8400