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% During , 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 $ % 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 Gross Domestic Product (GDP)7,897.38,440.28,967.79, , , , , ,282.0 Real GDP growth Consumer price index Urban per capita disposable income (RMB) 5,160.35,425.15,854.06,280.06,859.67,702.88,472.29, , Rural per capita net income (RMB)2,090.12,162.02,210.32,253.42,366.42,475.62,622.22, , Unemployment rate* Financial indicators M0 supply1,017.81,120.41,345.61,465.31,568.91,727.81,974.62,146.82,403.2 % growth over previous year M1 supply3,482.63,895.44,583.75,314.75,987.27,088.28,411.99, ,727.9 % growth over previous year M2 supply9, , , , , , , , ,876.0 % growth over previous year Exchange rate (RMB/$) Foreign exchange reserves (US$ billion) Government deficit NA Domestic debt NA Foreign debt ($ billion) NA 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 Copyright 2006 by the US-China Business Council. All rights reserved.

Rising Chinese Surpluses

Table 1: Foreign Investment in China, Jan.-Nov Note: Percentages may not add up because some categories were omitted from this table. Sources: Ministry of Commerce and the USCBC Investment VehicleNumber of ContractsAmount ContractedAmount Utilized Total% Change% of Total$ Billion% Change% of Total$ Billion% Change% of Total Foreign Direct Investment (FDI)43, Equity Joint Ventures11, Contractual Joint Ventures1, Wholly Foreign-Owned Enterprises 30, Share-based Enterprises with Foreign Investment Cooperative Development

Enormous Increase in FDI

Chinese Trade Data Incorrect

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

SourcePublicationDatePercent Undervalued World BankPPP Level200075% Big Mac IndexThe EconomistApr % PreegMAPISept % Yang and Bajeux- Besnainou Is the Chinese Currency Undervalued? Nov % based on PPP (using 1985 as fixed base year) WilliamsonIIE lectureOct. 2003Over 25% Anderson/UBSThe Complete RMB Handbook Oct. 2003Nearly 25% in real terms GoldsteinTestimony to CongressOct % O’Neill & WilsonGoldman Sachs Rpt.Sept % BhallaChinese Mercantilism: Currency Wars and How the East Was Lost July % as of 1998 Estimates of Undervaluation

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

X/R for Asian Currencies

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.