China’s Undervalued

Currency

Robert B. CassidyDirector 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%

• 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

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 1997 1998 1999 2000 2001 2002 2003 2004 2005

Gross Domestic Product (GDP) 7,897.3 8,440.2 8,967.7 9,921.5 10,965.5 12,033.3 13,582.3 15,987.8 18,282.0

Real GDP growth 9.3 7.8 7.6 8.4 8.3 9.1 10 10.1 9.9

Consumer price index 2.8 -0.8 -1.4 0.4 0.7 -0.8 1.2 3.9 1.8

Urban per capita disposable income (RMB)

5,160.3 5,425.1 5,854.0 6,280.0 6,859.6 7,702.8 8,472.2 9,421.60 10,493.00

Rural per capita net income (RMB) 2,090.1 2,162.0 2,210.3 2,253.4 2,366.4 2,475.6 2,622.2 2,936.40 3,255.00

Unemployment rate* 3.1 3.1 3.1 3.1 3.6 4 4.3 4.2 4.2

Financial indicators 1997 1998 1999 2000 2001 2002 2003 2004 2005

M0 supply 1,017.8 1,120.4 1,345.6 1,465.3 1,568.9 1,727.8 1,974.6 2,146.8 2,403.2

% growth over previous year 15.6 10.1 20.1 8.9 7.1 10.1 14.3 8.7 11.9

M1 supply 3,482.6 3,895.4 4,583.7 5,314.7 5,987.2 7,088.2 8,411.9 9,597.1 10,727.9

% growth over previous year 22.1 11.9 17.7 16 12.7 16.8 18.7 13.6 11.8

M2 supply 9,099.5 10,449.9 11,989.8 13,461.0 15,830.2 18,500.7 22,122.3 25,321.0 29,876.0

% growth over previous year 19.6 14.8 14.7 12.3 17.6 16.8 19.6 14.6 18

Exchange rate (RMB/$) 8.0 8.28 8.28 8.28 8.28 8.28 8.28 8.28 8.07

Foreign exchange reserves (US$ billion) 139.9 145.0 154.7 165.6 212.2 286.4 403.3 609.9 819.0

Government deficit 58.2 92.2 174.4 249.1 251.7 315 293.5 209.0 NA

Domestic debt 247.7 331.1 371.5 418.0 460.4 567.9 615.4 687.9 NA

Foreign debt ($ billion) 12.6 146.0 151.8 145.7 170.1 171.4 1936.3 228.6 NA

Sources: PRC National Bureau of Statistics (NBS), China Statistical Yearbook, 2004; The People's Bank of ChinaNotes:*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 SurplusesChina's Indexed Foreign Exchange Reserves and China's

Indexed Surplus with the U.S., Annually 1995-2005

0

200

400

600

800

1000

1200

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Year

Ind

exed

Val

ue

(199

5=10

0)

Indexed Surplus

Indexed FER

SOURC E: Official Statistics of the U.S. Department of Commerce, IM F International Financial Statistics

Prepared by Georgetown Economic Services

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 Vehicle Number of Contracts Amount Contracted Amount Utilized

  Total % Change % of Total $ Billion % Change % of Total $ Billion % Change % of Total

Foreign Direct Investment (FDI) 43,664 6.29 100.0 153.47 33.38 100.00 60.63 13.32 100.00

Equity Joint Ventures 11,570 -7.60 26.50 27.64 8.37 18.01 16.39 6.46 27.03

Contractual Joint Ventures 1,343 -13.19 3.08 7.79 4.13 5.08 3.11 -18.88 5.12

Wholly Foreign-OwnedEnterprises

30,708 13.97 70.33 117.28 43.70 76.42 40.22 20.49 66.34

Share-based Enterprises withForeign Investment

43 16.22 0.10 0.77 99.09 0.50 0.77 136.68 1.27

Cooperative Development 0 -100.00 0 0 -100.00 0 0.11 226.45 0.18

Enormous Increase in FDIForeign Direct Investment in China

0

10

20

30

40

50

60

70

80

90

100

110

120

130

140

150

160

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Year

Bil

lio

ns

of

U.S

. D

oll

ars

Total FDI Contracted

Total Utilized FDI

US Share of Total Utilized FDI*

US Share of Total FDI Contracted*

Source: China M inistry of Commerce

* Estimated for 2004

Prepared by Georgetown Economic Services

Chinese Trade Data Incorrect

Year China Data Partner Data Understatement1999 $27.8 $118.6 $90.82000 $30.4 $147.6 $117.22001 $26.0 $151.2 $125.32002 $31.5 $174.3 $142.82003 $29.7 $201.8 $172.12004 $45.8 $278.6 $232.8

2004 (Jan-Mar) ($3.1) $51.5 $54.62005 (Jan-Mar) $21.0 $81.0 $60.0

China’s Global Trade Surplus (Exports-Imports), Adjusted for Hong Kong Re-Export Trade, 1999 – 2005 YTD

By Source, in Billions of US$

Prepared by Georgetown Economic Services

Chinese Trade Data Incorrect

Country China Data Partner Data UnderstatementCanada $1,187 $13,512 $12,325Japan ($15,946) $15,752 $31,698

European Union (15) $35,232 $81,914 $46,682United States $84,674 $163,553 $78,879

Prepared by Georgetown Economic Services

Comparison of China-Reported Data with Trading Partner Data2004 Bilateral Trade Surplus(+)/Deficit(-)

Million U.S. Dollars

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

Source Publication Date Percent Undervalued

World Bank PPP Level 2000 75%

Big Mac Index The Economist Apr. 2003 56%

Preeg MAPI Sept. 2002 40%

Yang and Bajeux-Besnainou

Is the Chinese Currency

Undervalued?

Nov. 2003 27.99% based on PPP (using 1985 as fixed base

year)

Williamson IIE lecture Oct. 2003 Over 25%

Anderson/UBS The Complete RMB Handbook

Oct. 2003 Nearly 25% in real terms

Goldstein Testimony to Congress Oct. 2003 15-25%

O’Neill & Wilson Goldman Sachs Rpt. Sept. 2003 10-15%

Bhalla Chinese Mercantilism: Currency Wars and

How the East Was Lost

July 1998 10-15% 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

Chart 1: U.S. Dollar Exchange Rate for the YuanDaily, July 18th, 2005 - Present

4.9

5.2

5.5

5.8

6.1

6.4

6.7

7

7.3

7.6

7.9

8.2

8.5

Yu

an p

er U

.S. D

olla

r

Hypothetical Yuanper US$*

Actual Yuan perUS$

Yuan Revalued

40 Percent Appreciation

Progress to Date

X/R for Asian Currencies

Chart 2: U.S. Dollar Exchange Rates for Various Asian CurrenciesDaily, July 18th, 2005 - Present

91

93

95

97

99

101

103

105

107

109

7/1

8/2

00

5 =

10

0

China

Japan

Malaysia

South Korea

Yuan Revalued

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.