CHINESE CURRENCY DEVALUATION
INTRODUCTION
The U.S. trade deficit,
the difference between what America exports and what it
imports, has become a major story in recent years. As the
deficit continues to widen, this issue has seeped into the
public’s consciousness. Last year, the trade deficit was
$765.3 billion, up from $725.8 billion in 2005 and $617.6
billion in 2004. While most news outlets report this data as
a reflection of a struggling economy and a harbinger of
financial struggles in the future, traditionally, there has
been differing schools of thoughts among economists as to
whether the trade deficit is necessarily good or bad for the
economy.
Those who contend that
the trade deficit is a bad thing argue that when imports
displace domestic production, American jobs are lost. They
tend to point to the fact that the U.S. has lost over 3
million manufacturing jobs since 2001 due to the importing of
goods made in other countries rather than the U.S. exporting
these goods to the other countries.
On the other side of the
debate are economists who say the trade deficit is simply part
of the free market, the result of increased domestic demand
and foreign investment in our nation. They further point out
that there is little correlation between employment and trade
deficit. For instance, while three of the leading industrial
nations, Germany, Canada, and Japan, currently have a trade
surplus, their unemployment rates are 9.0 percent, 5.3 percent
rate, and 4.0 percent, respectively.
The issue of the trade
deficit becomes most inflamed when it is specifically centered
on China. In 2006, the U.S. trade deficit with China hit a
new high for the fifth straight year at $232.5 billion,
accounting for about one-third of the total U.S. trade deficit
for the year.
Trade with China has
increased dramatically over the past three decades. Total
trade (defined as exports plus imports) has increased from $5
billion in 1980 to $343 billion in 2006. China is now our
second largest trading partner, second largest source of
imports, and fourth largest export market.
As the trade deficit
with China has increased, so too has the concern about this
issue among U.S. lawmakers, particularly those who represent
areas where their constituents’ jobs were outsourced to
China. As it emerges as a key player in the world trade
market, China is struggling to reconcile its protectionist
instincts with the potential economic boom that fully
unlocking its market would entail. This is seen most clearly
in the trade policies that China has enacted. Chief among
these policies is the valuation of China’s currency.
“PEGGING” THE YUAN
From 1995 through 2005,
the yuan was “pegged” to the U.S. dollar at a fixed rate,
specifically, 8.28 yuan per dollar. The policy of pegging the
yuan to the dollar was originally implemented to stabilize the
Chinese economy and encourage international investment into
the nation’s budding economy. Investors could be confident
knowing what their exports would be worth in dollars. To this
end, the policy proved quite successful prompting businesses
to invest $60 billion annually in new factories and other
operations in China.
However, as the trade
deficit has widened, the U.S. has expressed, with considerable
concern, the view that the yuan is seriously undervalued.
Some analysts say the yuan needs to rise by as much as 40
percent in order to reflect its true value.
Chinese officials
maintain that the fixed rate is necessary to promote economic
stability, not to gain a trade advantage. They say without
the peg, fluctuations in the yuan's value could cause serious
dislocations in China's domestic economy. They fear that an
appreciated currency could reduce jobs and lower wages in
several sectors, resulting in worker unrest.
THE “NEW” SYSTEM
On July 21, 2005, China
announced that it would increase the value of its currency,
the yuan, and abandon its decade-old fixed exchange rate to
the U.S. dollar in favor of a "managed" float against a basket
of currencies, and that it would immediately revalue the yuan
to a rate of 8.11 to the dollar. The new system was intended,
Chinese officials said, to allow more flexibility and to
permit the international value of the yuan to be established
by market forces. The yuan was increased in value by 2
percent and a "crawling peg" was introduced so that the yuan
could rise gradually in value.
However, less than a
week later, China’s Central Bank stated that it had no
immediate plans for further revaluations and that reforms
would be done in a “gradual” way. Four months later, in its
November 28, 2005 report to Congress on exchange rate
policies, the Treasury Department concluded that China had
failed to fully implement its commitment to make its new
exchange rate mechanism more flexible and to increase the role
of market forces. Rather, the report stated that there was
little difference between the new policy and the old one of
pegging the yuan to the dollar. Surprisingly, Treasury did
not cite China as a manipulator of currency because of
China’s assurances that it was committed to “enhanced, market
determined currency flexibility.”
As might be expected,
many lawmakers expressed disappointment in both China’s
failures to change their monetary policy and Treasury’s
subsequent report. Since then, both Congress and the
Administration have stepped up pressure on China to make its
currency more flexible.
RECENT DEVELOPMENTS
On September 29, 2006,
President Bush and Chinese President Hu Jintao agreed to
establish a Strategic Economic Dialogue (SED) in order to have
discussions on major economic issues. The SEDs are intended
to address long-term strategic challenges rather than
immediate solutions. The first meeting, which was chaired by
Secretary of Treasury Henry Paulson and Chinese Vice Premier
Wu Yi, was held December 14-15, 2006. China’s currency policy
was a major item of discussion. Following this meeting, the
Treasury Department issued another report on exchange rate
policies that labeled China’s currency policy “a core issue”
in U.S.-China relations. The report noted that China had made
progress in 2006 with making its currency more flexible, but
that reforms were cautious and “considerably less than
needed.”
Between
July 2005 (when currency was revalued at 8.11 yuan to the
dollar) and April 20, 2007 (when the exchange rate was 7.72
yuan per dollar), the yuan has appreciated by about 4.8
percent.
During an April 14, 2007 International Monetary
Fund (IMF) meeting, Secretary of Treasury Paulson strongly
urged the IMF to adopt reforms to strengthen its surveillance
of international exchange rate policies, and to sharpen the
focus on fundamental exchange rate misalignment and inflexible
exchange regimes.
In June, 2007, Treasury
again indicated it did not believe China was manipulating its
currency for a trade advantage.
CONGRESSIONAL ACTION
Senators Charles Schumer
(D-NY) and Lindsey Graham (R-SC) have been two of the most
outspoken critics of China’s currency policy. In the last
Congress they had proposed legislation that would have imposed
a 27.5 tariff on Chinese goods, if China did not change its
currency policy. Opponents argued the proposal would violate
World Trade Organization (WTO) rules and that the President
would never sign the bill.
In this Congress,
Senators Schumer and Graham pledged to work with Finance
Committee Chairman Max Baucus (D-MT) and Ranking Member
Charles Grassley (R-IA) on another currency bill that would be
WTO compliant and veto-proof.
The result of this work
is S. 1607, the Currency Exchange Rate Oversight Reform Act,
introduced by Senator Baucus on June 13, 2007. He was joined
in unveiling the legislation by his three colleagues, who are
also the bill’s original cosponsors. While this bill does not
specifically mention China by name, it was crafted with the
nation in mind.
S. 1607 would require
the Treasury Department, twice a year, to identify countries
that have “fundamentally misaligned” currency values. If any
of the currencies are believed to be misaligned due to their
government’s economic policies, Treasury would be required to
mark those currencies as “priority action.” and to oppose any
changes in International Monetary Fund (IMF) rules benefiting
that nation. If a country with a non-market economy wishes to
receive market status, its currency status would have to be
evaluated.
This bill also sets
benchmarks for the designated country. If a “marked currency”
nation fails to take appropriate action within six months,
additional action would be necessary, including suspension of
U.S. government procurement, requests for special consultation
by the IMF, and suspension of loans and private insurance from
the Overseas Private Investment Corporation to U.S. companies
wishing to operate in that nation. If issues are not resolved
within one year, the legislation requires the U.S. Trade
Representative to commence WTO dispute settlement proceedings
regarding the currency problem, and requires the Treasury
Secretary to consider possible remedial intervention by the
Federal Reserve Board and other central banks.
Importantly, this bill
includes a Presidential waiver. At the six-month and
twelve-month marks, the President may waive the bill's
requirements if implementing them poses a threat to national
security or America's economic interests. But the bill also
increases congressional input by giving Congress the ability
to voice disapproval of the Presidential economic waiver.
Chairman Christopher
Dodd (D-CT) and Ranking Member Richard Shelby (R-AL) of the
Senate Committee on Banking, Housing, and Urban Affairs have
introduced their own legislation, the Currency Reform and
Financial Markets Access Act. This bill would clarify the
definition of currency manipulation so as to more adequately
identify countries guilty of this practice. The legislation
would require Treasury to submit a detailed plan of action to
Congress within 30 days of this identification, which will
contain timeframes and benchmarks to address the problem.
The legislation also
requires Treasury to engage in negotiations with nations that
manipulate their currency, as well as seek IMF consultation
and vote at the IMF accordingly. Treasury would also be given
the authority to file a World Trade Organization Article XV
case to remedy currency manipulation if the benchmarks are not
reached within nine months. As with S. 1607, Senators Dodd
and Shelby plan to expedite their legislation through their
committee.
OUTLOOK
The issue of currency
manipulation is a hot topic in this Congress. Heading into
the August recess, both the Senate Finance and the Senate
Banking, Housing, and Urban Affairs Committees approved their
respective bills by wide margins. In addition, the House Ways
and Means Trade Subcommittee conducted a hearing on the issue
on August 2, 2007.
Now that they have
control of both chambers of Congress, it appears as if the
Democrats will be far less willing to continue the hands-off
approach used by the Republican Congress and the Bush
Administration. It is expected that one, if not both, of these
bills will make it to the Senate floor for a full vote before
the end of the year.
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