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. 


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. 


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.   


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.


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.


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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