1. China’s Undervalued Currency Robert B. Cassidy Director of International Trade Collier Shannon Scott

2. 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

3. 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

4. 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

5. 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 indicators199719981999200020012002200320042005 Gross Domestic Product (GDP)7,897.38,440.28,967.79,921.510,965.512,033.313,582.315,987.818,282.0 Real GDP growth9.37.87.68.48.39.11010.19.9 Consumer price index2.8-0.8-1.40.40.7-0.81.23.91.8 Urban per capita disposable income (RMB) 5,160.35,425.15,854.06,280.06,859.67,702.88,472.29,421.6010,493.00 Rural per capita net income (RMB)2,090.12,162.02,210.32,253.42,366.42,475.62,622.22,936.403,255.00 Unemployment rate*3.1 3.644.34.2 Financial indicators199719981999200020012002200320042005 M0 supply1,017.81,120.41,345.61,465.31,568.91,727.81,974.62,146.82,403.2 % growth over previous year15.610.120.18.97.110.114.38.711.9 M1 supply3,482.63,895.44,583.75,314.75,987.27,088.28,411.99,597.110,727.9 % growth over previous year22.111.917.71612.716.818.713.611.8 M2 supply9,099.510,449.911,989.813,461.015,830.218,500.722,122.325,321.029,876.0 % growth over previous year19.614.814.712.317.616.819.614.618 Exchange rate (RMB/$)8.08.28 8.07 Foreign exchange reserves (US$ billion) 139.9145.0154.7165.6212.2286.4403.3609.9819.0 Government deficit58.292.2174.4249.1251.7315293.5209.0NA Domestic debt247.7331.1371.5418.0460.4567.9615.4687.9NA Foreign debt ($ billion)12.6146.0151.8145.7170.1171.41936.3228.6NA 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.

6. Rising Chinese Surpluses

7. 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 VehicleNumber of ContractsAmount ContractedAmount Utilized Total% Change% of Total$ Billion% Change% of Total$ Billion% Change% of Total Foreign Direct Investment (FDI)43,6646.29100.0153.4733.38100.0060.6313.32100.00 Equity Joint Ventures11,570-7.6026.5027.648.3718.0116.396.4627.03 Contractual Joint Ventures1,343-13.193.087.794.135.083.11-18.885.12 Wholly Foreign-Owned Enterprises 30,70813.9770.33117.2843.7076.4240.2220.4966.34 Share-based Enterprises with Foreign Investment 4316.220.100.7799.090.500.77136.681.27 Cooperative Development0-100.0000 00.11226.450.18

8. Enormous Increase in FDI

9. Chinese Trade Data Incorrect

11. 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$

12. 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

13. SourcePublicationDatePercent Undervalued World BankPPP Level200075% Big Mac IndexThe EconomistApr. 200356% PreegMAPISept. 200240% Yang and Bajeux- Besnainou Is the Chinese Currency Undervalued? Nov. 200327.99% 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. 200315-25% O’Neill & WilsonGoldman Sachs Rpt.Sept. 200310-15% BhallaChinese Mercantilism: Currency Wars and How the East Was Lost July 199810-15% as of 1998 Estimates of Undervaluation

14. 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

15. Progress to Date

16. X/R for Asian Currencies

17. 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

18. 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

19. 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

20. 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

21. 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.

22. 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.