China’s Currency: An Analysis of the
Economic Issues
Wayne M. Morrison
Specialist in Asian Trade and Finance
Marc Labonte
Specialist in Macroeconomic Policy
December 30, 2010
Congressional Research Service
7-5700
www.crs.gov
RS21625
CRS Report for Congress
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repared for Members and Committees of Congress
China’s Currency: An Analysis of the Economic Issues
Summary
Since 1994, the Chinese government has maintained a policy of intervening in currency markets
to limit or halt the appreciation of its currency, the renminbi (RMB), against the U.S. dollar and
other currencies. Critics charge that this policy has made Chinese exports to the United States
significantly cheaper, and U.S. exports to China much more expensive, than would occur under
free market conditions. Some policymakers argue that China’s currency policy is a major factor
behind the large annual U.S. trade deficits with China and has lead to the widespread loss of U.S.
manufacturing jobs. Some economists have argued that China’s currency policy is disruptive to
global economic recovery because it induces many countries to intervene in currency markets in
an effort to hold down the value of their currencies against the dollar in order to enable their firms
to remain competitive vis-à-vis Chinese firms. Some economists have expressed concern that
these actions may worsen economic imbalances and could undermine the world trading system.
From July 2005 to July 2008, the central bank of China allowed the RMB to appreciate against
the dollar by about 21%. However, once the effects of the global economic crisis began to
become apparent, China halted appreciation of the RMB in an effort to limit job losses in
industries dependent on trade. From July 2008 to late June 2010, China kept the exchange rate of
the RMB at roughly 6.83 yuan (the base unit of the RMB) to the dollar. On June 19, 2010, the
China’s central bank stated that, based on current economic conditions, it had decided to “proceed
further with reform of the RMB exchange rate regime and to enhance the RMB exchange rate
flexibility.” From June 18 to December 24, 2010, China allowed the RMB/dollar exchange rate to
rise by about 2.9%% overall. U.S. officials have criticized the slow pace of RMB’s appreciation,
especially given the rapid growth in Chinese exports and trade surplus over the past year, and
have urged China to quicken the pace of currency reform and flexibility.
Many Members of Congress have urged the Obama Administration take a more aggressive stand
against China over its currency policy, including designating it as a “currency manipulator” under
U.S. trade law. Several currency-related bills were introduced in the 111th Congress. In September
2010, the House approved an amendment in the nature of a substitute to H.R. 2378, which would
have attempted to treat certain fundamentally undervalued currencies as an actionable subsidy
under U.S. countervailing duty (which could have resulted in higher tariffs on certain imported
Chinese products). The Senate did not consider the bill. In addition to bilateral talks, the Obama
Administration has sought to put more pressure on China by attempting to boost multilateral
cooperation on addressing exchange rate policies and global trade imbalances.
Many economists contend that a sharp appreciation of the RMB would help to rebalance the
global economy, but note that this must be accompanied by lower saving and greater consumption
in China. An immediate and sharp appreciation of China’s currency could disrupt its export
industries and lead to widespread lay-offs, which in turn could slow its economic growth and
reduce import demand. However, if RMB appreciation occurred along with measures to boost
domestic consumption, laid off Chinese workers in the export sector would be able to find jobs in
other (non-export) sectors, which could help maintain healthy economic growth and boost
Chinese demand for imports. While an appreciation of the against the dollar could help boost U.S.
exports to China, it could also entail costs to the U.S. economy in the near term. China would not
need to buy as many U.S. Treasury securities, which could cause real U.S. interest rates to rise. A
more expensive RMB could also mean higher costs for U.S. consumers as well as firms that use
Chinese-made inputs for their products. To reduce U.S. external imbalances (including with
China), the United States would need to boost national saving.
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Contents
Introduction ................................................................................................................................ 1
Background on China’s Currency Policy ..................................................................................... 2
2005: China Reforms the Peg ................................................................................................ 2
RMB Developments and Policy Debate................................................................................. 4
Concerns in the United States Over China’s Currency Policy: Trade Deficits and Jobs................. 5
U.S. Legislative Proposals on Undervalued Currencies.......................................................... 9
The Obama Administration’s Position and Policies.............................................................. 10
An Economic Analysis of the Effects of China’s Currency on the U.S. Economy....................... 11
Is the RMB Undervalued, and if so, by How Much? ............................................................ 11
Why do Estimates of the RMB’s Undervaluation Differ so Much?....................................... 12
The Debate over the Effects of Exchange Rate Appreciation on Trade Flows and the
Deficit.............................................................................................................................. 14
The Bilateral Trade Deficit Continued to Grow during the Previous Period of
RMB Appreciation ..................................................................................................... 15
The J Curve Effect ........................................................................................................ 15
The Role of Exchange Rate Pass-Through..................................................................... 16
China’s Role in the Global Supply Chain....................................................................... 16
Underlying Macroeconomic Imbalances Are Unlikely to Disappear .............................. 16
Differing Opinions on Making RMB Appreciation a Top U.S. Trade Priority................. 17
Winners and Losers of RMB Appreciation from an Economic Perspective........................... 18
Effect on U.S Exporters and Import-Competitors........................................................... 18
Effect on U.S. Consumers and Certain Producers .......................................................... 18
Effect on U.S. Borrowers .............................................................................................. 19
Net Effect on the U.S. Economy.................................................................................... 19
China’s Perspective and Concerns: Economic Growth and Stability........................................... 20
The Effects of an Undervalued RMB on China’s Economy.................................................. 22
Policy Options for the RMB and Potential Outcomes ................................................................ 24
Current Account Balances, Savings, and Investment............................................................ 28
Sources of Economic Growth.............................................................................................. 32
Investment and Consumption Relative to GDP .............................................................. 33
Figures
Figure 1. Nominal RMB/Dollar Exchange Rate: January 2008 to June 2010................................ 3
Figure 2. Change in China’s Real Trade Weighted Exchange Rate: July 2008-September
2010 ........................................................................................................................................ 4
Figure 3. The Yuan-Dollar Exchange Rate: June 18-December 24, 2010...................................... 5
Figure 4. China’s Current Account Balance and Annual Change in Foreign Exchange
Reserves: 2001-2009................................................................................................................ 7
Figure 5. China’s Monthly Trade Flows: January 2008-September 2010 .................................... 22
Figure A-1. Chinese and U.S. Current Account Balances: 2000-2009 ........................................ 29
Figure A-2. Chinese and U.S. Current Account Balances as a Percent of GDP: 2000-2009 ........ 30
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Figure A-3. Gross National Savings as a Percent of GDP for China and the United States:
1990-2009.............................................................................................................................. 31
Figure A-4. U.S. Real GDP Growth and Sources of GDP Growth: 2003-2009 ........................... 32
Figure A-5. Chinese Real GDP Growth and Sources of GDP Growth......................................... 33
Figure A-6. Gross Investment as a Percent of GDP for Selected Economies: 2008 ..................... 34
Figure A-7. Private Consumption as a Percent of GDP for Selected Economies: 2008................ 34
Figure A-8.Annual Growth in Real Chinese and U.S. Private Consumption: 2000-2009 ............ 35
Tables
Table A-1. Ratio of Gross National Savings to Gross Investment and Current Account
Balances as a Percent of GDP for Various Economies: 2008 ................................................... 28
Appendixes
Appendix. Indicators of U.S. and Chinese Economic Imbalances............................................... 27
Contacts
Author Contact Information ...................................................................................................... 35
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China’s Currency: An Analysis of the Economic Issues
Introduction
China’s policy of intervention to limit the appreciation of its currency, the renminbi (RMB), or
yuan, against the dollar and other currencies has become a major source of tension with many of
its trading partners, especially the United States.1 Some analysts contend that China deliberately
“manipulates” its currency in order to gain unfair trade advantages over its trading partners. They
further argue that China’s undervalued currency has been a major factor in the large annual U.S.
trade deficits with China and the loss of millions of U.S. manufacturing jobs, and, because of the
current high rate of U.S. unemployment, can no longer be tolerated. President Obama stated in
February 2010 that China’s undervalued currency puts U.S. firms at a “huge competitive
disadvantage,” and he pledged to make addressing China’s currency policy a top priority.
Chinese officials have maintained that China’s currency policies are intended to promote
economic stability and do not negatively impact other countries. From July 2005 to July 2008,
China allowed the RMB to gradually appreciate against the dollar. However, once the effects of
the global economic crisis became apparent, the appreciation of the RMB was halted and the
exchange rate with the dollar was held constant at 6.83 yuan. This move was criticized by many
of China’s major trading partners, including the United States and the European Union. China
responded by calling the growing international pressure on China to appreciate its currency
“protectionism.” However, on June 19, 2010, the People’s Bank of China stated that, based on
current economic conditions, it had decided to “proceed further with reform of the RMB
exchange rate regime and to enhance the RMB exchange rate flexibility.”
The pace of the RMB’s appreciation since that announcement has been criticized as being too
slow. On September 29, 2010, the House passed an amended version of H.R. 2378, which would
attempted to treat a fundamentally undervalued currency as an actionable subsidy under U.S.
countervailing laws (which could have raised U.S. tariffs on certain imported Chinese products).
The Senate did not consider the bill.
Although economists differ as to the extent of the RMB’s undervaluation against the dollar and
the economic effects that undervaluation has on China’s major trading partners, including the
United States (many cite both positive and negative effects), most agree that currency flexibility
would be an important factor in helping to reduce global imbalances, which are believed to have
been a major factor that sparked the global financial crisis and economic slowdown. They further
contend that currency reform is in China’s own long-term economic interest. However, many
economists argue that a Chinese currency appreciation will do little to reduce trade imbalances in
the United States and China unless such action is accompanied by changes to U.S. and Chinese
macroeconomic practices (i.e., the United States would need to save more and consume less and
China would need to save less and consume more), which could lower overall U.S. imports
(including from China) and boost China’s overall imports (including from the United States). In
addition, some analysts contend that Chinese industrial policies pose a much greater challenge to
U.S. economic interests than an undervalued currency.
This report provides an overview of the economic issues surrounding the current debate over
China’s currency policy. It identifies the economic costs and benefits of China’s currency policy
1The official name of China’s currency is the renminbi (RMB), which is denominated in yuan units. Both RMB and
yuan are used interchangeably to describe China’s currency.
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for both China and the United States, and possible implications if China were to allow its
currency to significantly appreciate or to float freely. It also examines proposed legislation in the
111th Congress that seek to address China’s currency policy.
Background on China’s Currency Policy
Prior to 1994, China maintained a dual exchange rate system. This consisted of an official fixed
exchange rate system (which was used by the government), and a relatively market-based
exchange rate system that was used by importers and exporters in “swap markets,” although
access to foreign exchange was highly restricted in order to limit imports, resulting in a large
black market for foreign exchange. The two exchange rates differed significantly. The official
exchange rate with the dollar in 1993 was 5.77 yuan versus 8.70 yuan in the swap markets.
China’s dual exchange rate system was criticized by the United States because of the restrictions
it (and other policies) placed on foreign imports.
In 1994, the Chinese government unified the two exchange rate systems at an initial rate of 8.70
yuan to the dollar, which eventually was allowed to rise to 8.28 by 1997 and was then kept
relatively constant until July 2005. The RMB became largely convertible on a current account
(trade) basis, but not on a capital account basis, meaning that yuan are not regularly obtainable for
investment purposes. From 1994 until July 2005, China maintained a policy of pegging the RMB
to the U.S. dollar at an exchange rate of roughly 8.28 yuan to the dollar. The peg appears to have
been largely intended to promote a relatively stable environment for foreign trade and investment
in China (since such a policy prevents large swings in exchange rates)—a policy utilized by many
developing countries in their early development stages. The Chinese central bank maintained this
peg by buying (or selling) as many dollar-denominated assets in exchange for newly printed yuan
as needed to eliminate excess demand (supply) for the yuan. As a result, the exchange rate
between the RMB and the dollar basically stayed the same, despite changing economic factors
which could have otherwise caused the yuan to appreciate (or depreciate) relative to the dollar.
Under a floating exchange rate system, the relative demand for the two countries’ goods and
assets would determine the exchange rate of the RMB to the dollar.
2005: China Reforms the Peg
The Chinese government modified its currency policy on July 21, 2005. It announced that the
RMB’s exchange rate would become “adjustable, based on market supply and demand with
reference to exchange rate movements of currencies in a basket,”2 and that the exchange rate of
the U.S. dollar against the RMB was adjusted from 8.28 yuan to 8.11, an appreciation of 2.1%.
Unlike a true floating exchange rate, the RMB would be allowed to fluctuate by up to 0.3% (later
changed to 0.5%) on a daily basis against the basket.
After July 2005, China allowed the RMB to appreciate steadily, but very slowly. From July 21,
2005 to July 21, 2008, the dollar-RMB exchange rate went from 8.11 to 6.83, an appreciation of
18.7% (or 20.8% if the initial 2.1% appreciation of the RMB to the dollar is included). The
2 It was later announced that the composition of the basket would include the dollar, the yen, the euro, and a few other
currencies, although the currency composition of the basket has never been revealed. If the value of the yuan were
determined according to a basket of currencies, however, it would not have shown the stability it has had against the
dollar between mid-2008 and mid-2010, unless the basket were overwhelmingly weighted toward dollars.
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situation at this time might be best described as a “managed float”—market forces determined the
general direction of the RMB’s movement, but the government retarded its rate of appreciation
through market intervention. China halted its currency appreciation policy around mid-July 2008
(see Figure 1) mainly because of declining global demand for Chinese products that resulted
from the effects of the global financial crisis. The RMB depreciated against the dollar slightly in
July-August 2008 and in December 2008, but generally was kept constant at 6.83 yuan through
around mid-June 2010.
Figure 1. Nominal RMB/Dollar Exchange Rate: January 2008 to June 2010
Yuan per $U.S. (Monthly Averages)
Source: Global Insight and the Bank of China “middle rate.”
Note: Chart inverted for illustrative purposes. A rising line indicates appreciation of the RMB to the dollar and a
falling line indicates depreciation.
China’s relative peg to the dollar after July 2008 has meant that as the dollar depreciated or
appreciated against a number of major currencies, China’s currency depreciated or appreciated as
well (even though the RMB’s exchange rate with the dollar remained constant). From July 2008
to May 2010, the real (inflation adjusted) trade-weighted exchange rate of China’s currency based
on its trade with 57 economies appreciated by 8.9%. Although China’s real trade-weighted
exchange rate depreciated through much of 2009, it began to rise in 2010, due in part to the
effects of the debt crisis in the Eurozone countries and the depreciation of the euro against the
dollar (see Figure 2). From January to September 2010, the trade-weighted exchange rate of
China’s currency against the currencies of these economies increased by 5.2%
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Figure 2. Change in China’s Real Trade Weighted Exchange Rate: July 2008-
September 2010
Index Based on Average Annual 2005 Data (2005=100)
Source: Bank of International Settlements.
Note: Weights calculated based on China’s trade with 57 economies. Inflation calculated using measurements of
national consumer price indexes.
RMB Developments and Policy Debate
China has expressed strong opposition to outside pressure on its currency policy, calling it a form
of protectionism and interference in China’s domestic economic policy. However, on June 19,
2010, China’s central bank, the People’s Bank of China (PBC), stated that, based on current
economic conditions, it had decided to “proceed further with reform of the RMB exchange rate
regime and to enhance the RMB exchange rate flexibility.” It ruled out any large one-time
revaluations, stating “it is important to avoid any sharp and massive fluctuations of the RMB
exchange rate,” in part so that Chinese corporations could more easily adjust (such as through
upgrading) to an appreciation of the currency. Many observers contend the timing of the RMB
announcement was intended in part to prevent China’s currency policy from being a central focus
of the G-20 summit in Toronto from June 26-27, 2010.
On June 22, 2010, the RMB appreciated by 0.43% against the dollar (to 6.80 yuan) over the
previous day, which, at the time, was the largest daily rise since reforms were implemented in
July 2005. However, on the following day (June 23) it depreciated to 6.81 yuan.3 As indicated in
Figure 3, the yuan’s exchange rate with the dollar has gone up and down over the past few
3 The fact that the currency has appreciated some days but has depreciated on others raises a number of questions as to
the extent and pace the PBC will allow the RMB to appreciate over time. Many observers believe that this is a sign that
appreciation of the RMB will happen over a long period of time, but in an unpredictable way in an effort to limit RMB
speculation and inflows of “hot money,” which could destabilize China’s economy.
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months, but overall, it has appreciated by about 2.9% overall through December 24, 2010. A large
amount of the RMB’s appreciation against the dollar (from June to December 2010) occurred in
September 2010. Some analysts argue that this had more to do with Chinese attempts to try to
prevent possible congressional action against China’s currency policy than economic
considerations.4
Figure 3. The Yuan-Dollar Exchange Rate: June 18-December 24, 2010
Yuan per U.S. dol ar
Source: Bank of China official middle rate.
Notes: End of week (Friday) middle exchange rate. Chart inverted for illustrative purposes to show the
appreciation or depreciation of the RMB against the dollar.
Concerns in the United States Over China’s
Currency Policy: Trade Deficits and Jobs
Many U.S. policymakers and business and labor representatives have charged that the Chinese
government manipulates its currency in order to make it significantly undervalued vis-à-vis the
U.S. dollar, thus making Chinese exports to the United States significantly cheaper, and U.S.
exports to China much more expensive, than they would be if exchange rates were determined by
market forces. They note that, while a pegged currency may have been appropriate during China’s
early stages of economic development, it can no longer be justified, given the size of China’s
economy and trade flows and the impact China’s economic policies have on the global economy.5
4 The House Committee on Ways and Means and the Senate Banking Committee both had hearings on China’s
currency in September 2010.
5 China became the world’s second largest merchandise exporter in 2009 (after the European Union) and accounted for
(continued...)
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Critics further argue that the undervalued currency has been a major factor behind the burgeoning
U.S. trade deficit with China, which surged from $10 billion in 1990 to $266 billion in 2008 (but
declined to $226 billion in 2009). Other factors viewed by some as evidence of Chinese currency
manipulation are China’s massive accumulation of foreign exchange reserves, which grew from
$403 billion in 2003 to $2,454 billion as of June 2010 and its large annual current account
surpluses, which grew from $46 billion in 2003 in $426 billion in 2008 (although the surplus in
2009 fell significantly) (see Figure 4). In a July 2010 report, the IMF warned that, over the
medium-term, there was potential for sizable current account surpluses to return as China’s policy
stimulus is wound down and the global economy recovers.6 The IMF’s October 2010 World
Economic Outlook projects that China’s current account will fall from $297 billion in 2009 to
$270 billion in 2010, but then will rise to $325 billion in 2011,and by the year 2015, it will
increase to $778 billion.7 Global Insight predicts that China’s foreign exchange reserves will
increase to $3,194 billion, which would be an increase of $740 billion over June 2010 levels.8
Some analysts contend that there is a direct correlation between the U.S. trade deficit and U.S. job
losses, especially in the manufacturing center. For example, a study by the Economic Policy
Institute claims that the U.S. trade deficit with China led to the loss or displacement of 2.4 million
manufacturing jobs between 2001 and 2008.9 The current high rate of unemployment in the
United States appears to have intensified concerns over the perceived economic impact of China’s
currency policy. Furthermore, some analysts contend that China’s currency policy induces other
East Asian economies to intervene in currency markets in order to keep their currencies weak
against the dollar in order to compete with Chinese goods, which is viewed as preventing further
depreciation of the dollar to other Asian currencies, and thus diminishes U.S. exports throughout
Asia. Based on the assumption that China’s currency is undervalued by at least 40% against the
dollar and 25% on a trade weighted basis, C. Fred Bergsten from the Peterson Institute for
International Economics estimates that a market-based Chinese currency would result in a large
appreciation of the RMB and other Asian currencies against the dollar (or in other words a
depreciation of the dollar to Asian currencies), which would boost U.S. exports and generate an
additional 600,000 to 1.2 million jobs in the United States.10 U.S. economist Paul Krugman
contends that the undervalued RMB has become a significant drag on global economic recovery,
estimating that it has lowered global GDP by 1.4%, and has especially hurt poor countries.11
Claims about the negative effect of China’s exchange rate on U.S. employment and trade are
often juxtaposed with the observation that China’s economy grew more rapidly than any
(...continued)
9.5% of global exports. China is also estimated to be the world’s second largest economy.
6 IMF, People’s Republic of China: 2010 Article IV Consultation—Staff Report; Staff Statement; Public Information
Notice on the Executive Board Discussion, July 2010, p. 1.
7 IMF, World Economic Outlook Database, October 2010.
8 These accumulations occur even with a forecast of the yuan-dollar exchange rate to rise at 5.68 by 2015. Source:
Global Insight, China, Detailed Forecast, Balance of Payments, August 12, 2010.
9 Economic Policy Institute, Unfair China Trade Costs Local Jobs 2.4 Million Jobs Lost, Thousands Displaced in
Every U.S. Congressional District, Briefing Paper #260, March 23, 2010, available at http://epi.3cdn.net/
91b2eeeffce66c1a10_v5m6beqhi.pdf.
10 C. Fred Bergsten, Peterson Institute for International Economics, Testimony before the Committee on Ways and
Means, US House of Representatives, March 24, 2010. However, in testimony to the House Committee on Ways and
Means on September 15, 2010, Bergsten stated that “elimination of the Chinese misalignment would create about half a
million US jobs.” See testimony at: http://www.iie.com/publications/testimony/bergsten20100915.pdf.
11 New York Times, March 14, 2010, and December 31, 2009. Krugman also estimates that China’s currency policy
has caused 1.4 million job losses in the United States.
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advanced economy from 2007 to 2009, averaging 10.4% per year.12 This has led some
commentators to complain that China’s exchange rate peg represents a “beggar thy neighbor”
policy (i.e., meant to promote Chinese economic development at the expense of other countries)
at a time of global economic crisis. (The validity of claims about the RMB’s effect on the U.S.
economy will be analyzed in the section below entitled “An Economic Analysis of the Effects of
China’s Currency .”)
Figure 4. China’s Current Account Balance and Annual Change in Foreign Exchange
Reserves: 2001-2009
$billions
Source: Economist Intelligence Unit and Chinese State Administration of Foreign Exchange.
Note: Year end values.
12 Based on data from the International Monetary Fund.
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Is China a “Currency Manipulator?”
The U.S. Department of the Treasury is required on a biannual basis to issue a Report to Congress on International
Economic and Exchange Rate Policies of major U.S. trading partners,13 and to “consider whether countries manipulate
the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance
of payments adjustments or gaining unfair competitive advantage in international trade.”14 If such manipulation is
found to exist with respect to countries that have material global current account surpluses and have significant
bilateral trade surpluses with the United States, the Secretary of the Treasury is directed to initiate negotiations with
such countries on an expedited basis in the International Monetary Fund or bilaterally, for the purpose of ensuring
that such countries regularly and promptly adjust the rate of exchange between their currencies and the U.S. dol ar to
permit effective balance of payments adjustments and to eliminate the unfair advantage. China was cited as a currency
manipulator five times by Treasury from May 1992 and July 1994 over such issues as its dual exchange rate system,
periods of currency devaluation, restrictions on imports, and lack of access to foreign exchange by importers.
Many Members of Congress have expressed frustration that Treasury has not cited China as a currency manipulator
in recent years.15 Observers note that the language in the statute is somewhat unclear as to what policies constitute
actual currency manipulation (and the extent of Treasury’s discretion to make such a determination). A 2005
Treasury Department report stated that such a determination under the guiding statute was “inherently difficult”
because of the interplay of macroeconomic and microeconomic forces throughout the world, but said that such a
designation could be made if the authorities of an economy “intentionally act to set the exchange rate at levels, or
ranges, such that for a protracted period the exchange rate differs significantly from the rate that would have
prevailed in the absence of action by the authorities.”16 A 2005 Government Accountability Office (GAO) report on
the Treasury Department’s currency reports stated that in order for Treasury to reach a positive determination of
currency manipulation, a country would have to have a material global current account surplus and a significant
bilateral trade surplus with the United States, and would have to be manipulating its currency with the “intent” of
gaining a trade advantage. Some observers contend that Treasury will not cite China as a currency manipulator
because it can not prove that China’s currency policy is “intended” to give it an unfair trade advantage, since Chinese
government intervention in currency markets attempts to slow or halt the appreciation of the RMB (as opposed to
sharply depreciating the RMB). Other observers contend that as long as China continues to take steps to make its
currency more flexible, Treasury will refrain from citing China. A third theory states that citing China as a currency
manipulator would have no practical effect (especially since China and the United States are already engaged on this
issue at the highest government level) other than to “name and shame,” a policy that could anger the Chinese
government without producing any concrete results. However, some U.S. policy analysts and Members of Congress
have strongly urged the Treasury Department to designate China as a currency manipulator in order to “name and
shame it.” By doing so, it is argued, the United States would be sending a message that it was no longer willing to
tolerate China’s currency policy and it could encourage other countries to ral y behind the U.S. position (including
within the International Monetary Fund which exercises surveillance of its members currency policy), and could
possibly lead to multilateral meeting/agreement on global exchange rate realignment.17 Several bills have been
introduced in Congress over the past few years that would attempt to limit the Treasury Department’s discretion in
taking action on undervalued currencies by requiring it to indentify certain misaligned currencies based on a specific
criteria, regardless of intent of the currency policy.
13 As required under Section 3004 of Omnibus Trade and Competitiveness Act of 1988 (22 U.S.C 5305).
14 This language appears to have been taken from Article IV, Section 1 (iii) of the Articles of Agreement of the
International Monetary Fund (IMF) which states that members should, among other things “avoid manipulating
exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to
gain an unfair competitive advantage over other members.”
15 Many Members sharply criticized the Department of the Treasury’s decision in April 2010 to delay issuing its first
2010 exchange rate report (usually issued in March or April). That report was issued on July 8, 2010 (after China made
its announcement on currency reform) and it did not cite China (or any other country) for currency manipulation.
16 U.S. Department of Treasury, Semiannual Report on International Economic and Exchange Rate Policies, Appendix:
Analysis of Exchange Rates Pursuant to the Act, November 2005.
17 Testimony by C. Fred Bergsten, Peterson Institute of International Economics, Correcting the Chinese Exchange
Rate: an Action Plan, before the House Ways & Means Committee, March 24, 2010.
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U.S. Legislative Proposals on Undervalued Currencies
Numerous bills have been introduced in Congress over the past few years that have sought to
induce China to reform its currency policy or to address the perceived effects that policy has on
the U.S. economy. For example, one bill introduced in the 108th Congress by Senator Schumer (S.
1586) sought to impose additional duties of 27.5% on imported Chinese products if China did not
appreciate its currency to near market levels.18
In the 111th Congress, currency bills included H.R. 2378 (Tim Ryan), S. 1027 (Stabenow), S.
1254 (Schumer), and S. 3134 (Schumer). These bills sought to address the effects of misaligned
currencies in the following ways:
• S. 1254 and S. 3134 would have redefined the criteria under which a country
would be cited for possible action in the Treasury Department’s biannual reports
on exchange rates. Rather than use the term “manipulation” and the implied
criteria of “intent” to gain an unfair trade advantage, the bills would instead have
required the Treasury Department to identify “fundamentally misaligned
currencies.”
• All four bills made references to currencies that are fundamentally misaligned
according to specified indicators and methodologies, which would have triggered
certain actions. Each bill specified how currency misalignment was to be
determined.
• S. 1254 and S. 3134 would have, under certain circumstances, mandated a
number of other actions in regards to countries whose currencies were identified
for priority action, including a ban on their participation in federal government
procurement (unless the country was a member of the World Trade
Organization’s Agreement on Public Procurement or for loan programs
administered by the U.S. Overseas Private Investment Corporation (OPIC).19 In
addition, U.S. executive directors at multilateral banks would have been required
to oppose the approval of new loans of the targeted country, and U.S. officials
would have been directed to request action in the International Monetary Fund
(IMF) and the World Trade Organization (WTO) to address the misaligned
currency.
• All four bills required that currency misalignment be used as a factor for the
purposes of U.S. anti-dumping investigations and the calculation of anti-dumping
duties for imported products determined to be sold at less than fair market value
and injure a U.S. industry. H.R. 2378 and S. 1027 also would have required
currency misalignment to be used as a factor in U.S. countervailing
investigations (involving government subsidies) and the calculation of
countervailing duties for imported products determined to injure a U.S.
industry.20 S. 3134 would have required the Commerce Department to investigate
18 The sponsors of the bill at that time arrived at the 27.5% tariff figure by taking a simple average of the range of
estimates of China’s undervaluation, which were listed at 15%-40%.
19 OPIC operations in China have been suspended by the United States since 1989 because of the Tiananmen Square
massacre.
20 For an explanation of U.S. trade remedy laws and procedures, see CRS Report RL32371, Trade Remedies: A Primer,
by Vivian C. Jones.
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and determine whether currency undervaluation was providing, either directly or
indirectly, a subsidy that is already applicable under U.S. countervailing laws.
Supporters of the bills to apply U.S. anti-dumping and countervailing measures to address the
effects of China’s undervalued currency contended that the WTO allows countries (under certain
conditions) to administer their own trade remedy laws, and thus, making currency undervaluation
a factor in determining countervailing or anti-dumping duties was consistent with WTO rules.
Critics of the bills countered that WTO rules do not specifically include currency undervaluation
as a factor that can be used to implement trade remedy actions, and thus, such proposals, had they
been enacted, would likely have been challenged by China and other WTO members as a
violation of WTO rules.
On September 22, 2010, Congressman Levin announced that the House Ways and Means
Committee would consider an amendment in the nature of a substitute to H.R. 2378. The
amended version of H.R. 2378 attempted to address concerns by Administration officials and
some in Congress over passing a bill that was consistent with WTO rules. The Levin bill would
have amended U.S. trade law to “clarify that countervailing duties may be imposed to address
subsidies relating to a “fundamentally undervalued currency.” 21 The bill would have clarified that
a fundamentally undervalued currency could be treated as a benefit conferred by a foreign
government to its exports under U.S. countervailing law. In addition, the bill sought to clarify that
in the case of a subsidy relating to a fundamentally undervalued currency, the fact that the subsidy
may have also been provided in circumstances not involving export (i.e., it benefited non-
exporting firms as well as exporting firms) would not, for that reason alone, meant that the
subsidy could not have been considered contingent upon export performance. The bill directed
the Commerce Department to use, if possible, data and methodologies used by the International
Monetary Fund (IMF) to estimate real effective exchange rate undervaluation. The Ways and
Means Committee approved the bill by voice vote on September 25, and the House approved it
on September 29, 2010 by a vote of 348 to 79. However, the Senate did not consider the bill.
The Obama Administration’s Position and Policies
Administration officials have welcomed greater congressional involvement on the China currency
issue as long as legislative proposals do not violate U.S. WTO obligations and do not complicate
on-going bilateral and multilateral negotiations with China on the issue. The Administration did
not publicly indicate where or not it supported the House-passed version of H.R. 2378.
The Obama Administration has sought to directly engage China on the currency issue through the
Strategic & Economic Dialogue (S&ED) and the Joint Commission on Commerce and Trade
(JCCT). It addition, it has sought to use multilateral channels, such as the Group of 20 (G-20) and
the IMF, as a means to boost international cooperation on external balances and exchange rate
policies and to bring more pressure on China to appreciate its currency.22 On October 20, 2010,
21 The criteria for a fundamentally undervalued currency would have included one where the government was engaged
(over the past 18 months) in protracted, large-scale foreign exchange intervention; the real effective exchange rate was
undervalued by 5 percent; the country had experienced significant and persistent global current account surpluses; and
the foreign asset reserves held by the government exceeded certain benchmarks (such as the value of the country’s
imports during the previous four months).
22 The multilateral approach may also act as an inducement for China to reform its currency policies. If other
economies (especially Asia.) agree not to intervene in currency markets to prevent their currencies from appreciating
(or depreciate them to gain a competitive edge against Chinese exporters), China might agree to quicken the its pace of
(continued...)
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U.S. Treasury Secretary Timothy Geithner issued a proposal aimed at the G-20 meeting of finance
ministers and central bank governors on October 23, 2010. The proposal contained three main
points:23
• G-20 countries should commit to taking steps to reduce external imbalances
(both surpluses and deficits) below a specified share of GDP over the next few
years.
• G-20 countries should commit to refrain from exchange rate policies designed to
achieve competitive advantage by either weakening their currency or preventing
appreciation of an undervalued currency. G-20 emerging market countries with
significantly undervalued currencies (and adequate precautionary foreign
exchange reserves) need to allow their exchange rates to adjust fully over time to
levels consistent with economic fundamentals. G-20 advanced economies should
work to ensure against excessive volatility and disorderly movements in
exchange rates.
• The G-20 should call on the IMF to assume a special role in monitoring progress
on these commitments and should publish a semiannual report assessing progress
the G-20 countries have made to achieve these goals.24
China and a number of other G-20 members, though supporting efforts to rebalance the global
economy, opposed the idea of using numerical targets. On November 3, 2010, the Federal
Reserve announced that it would purchase an additional $600 billion of Treasury securities.25
China criticized the move, arguing that it would lead to a sharp devaluation of the dollar against
global currencies and could destabilize the economies of developing countries.
An Economic Analysis of the Effects of China’s
Currency on the U.S. Economy
This section examines a number of issues pertaining to the effects of China’s undervalued
currency on the U.S. economy. The economic effects of an undervalued RMB on the Chinese
economy is examined later in the report.
Is the RMB Undervalued, and if so, by How Much?
Given the rapid increase of China’s exports and FDI inflows from 1994 (when the dollar peg was
established) through the present time, one would have expected China’s currency to have
(...continued)
currency appreciation and reform. If China went ahead and appreciated its currency, other Asian economies might do
the same. This might help minimize Chinese concerns that an appreciating currency would disrupt its export sector.
23 Department of Treasury, Dear G-20 Colleagues letter, October 20, 2010.
24 For additional information on the role of the IMF and proposals to strengthen surveillance of the exchange rate
policies of its members, see CRS Report RS22658, Currency Manipulation: The IMF and WTO, by Jonathan E.
Sanford
25 For more information on this action, see CRS Report R41540, Quantitative Easing and the Growth in the Federal
Reserve’s Balance Sheet, by Marc Labonte.
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appreciated against the currencies of its major economic and trading partners, including the
United States, had the RMB exchange rate been determined solely by market forces. To prevent
appreciation, China has accumulated official foreign reserves equal to $2.5 trillion. The IMF over
the past few years has stated that the RMB is undervalued, but in February 2010, it stated that the
RMB was “assessed to be substantially undervalued from a medium-term perspective.”26
There are numerous estimates of the RMB’s undervaluation against the dollar, although the
results vary widely depending on the methodologies and various assumptions used.27 Recent
estimates of the RMB’s undervaluation (and the year the estimate was made) include:
• 12% (December 2009) by Helmut Reisen with the Organization of Economic
Cooperation and Development;28
• 25% (December 2009) by Dani Rodrik of Harvard University (2009);29
• 30% (April 2010) by Arvind Subramanian at the Peterson Institute for
International Economics;30
• 40.2% (January 2010) 31 and 24.2% (June 2010)32 by William R. Cline and John
Williamson at the Peterson Institute for International Economics; and
• 50% (October 2009) by Niall Ferguson (Harvard University) and Moritz
Schularick (Free University of Berlin).33
Why do Estimates of the RMB’s Undervaluation Differ so Much?
There are two main methods used in the estimates presented above. One method is referred to as
the fundamental equilibrium exchange rate (FEER) method. It is based on the belief that current
account balances around the world are temporarily out of line with their “fundamental” value.
Once an estimate has been made of what the fundamental current account balance should be, one
can calculate how much the exchange rate must change in value to achieve that current account
26 IMF, Meetings of G-20 Deputies, Seoul, Korea, Global Economic Prospects and Policy Challenges, February 27,
2010.
27 For a survey of methodologies used to estimate a currency’s true value, see CRS Report RL32165, China’s
Currency: Economic Issues and Options for U.S. Trade Policy, by Wayne M. Morrison and Marc Labonte.
28 Reisen, Helmut, On the Renminbi and Economic Convergence, December 17, 2009. Available at
http://www.voxeu.org/index.php?q=node/4397.
29 Rodrick, Dani, Making Room for China in the World Economic, December 17, 2009. Available at
http://www.voxeu.org/index.php?q=node/4399.
30 Subramani, Arvind, New PPP-Based Estimates of Renminbi Undervaluation and Policy Implications, Peterson
Institute For International Economics Policy Brief, number PB10-8, April 2010. Available at http://www.iie.com/
publications/pb/pb10-08.pdf.
31 Cline, William R and John Williamson, Notes on Equilibrium Exchange Rates, Peterson Institute for International
Economics, Policy Brief PB10-2, January 2010, available at http://www.iie.com/publications/interstitial.cfm?
ResearchID=1472. This study also made estimates of the fundamental equilibrium exchange rate for 29 other countries,
of which a number of which were estimated to be undervalued while some were deemed to be overvalued.
32Cline, William R and John Williamson, Peterson Institute for International Economics, Peterson Institute for
International Economics, Estimates of Fundamental Equilibrium Exchange Rates, May 2010, Policy Brief 10-15, June
2010. Available at http://www.petersoninstitute.org/publications/interstitial.cfm?ResearchID=1596.
33 Harvard Business School, The End of Chimarica, by Niall Ferguson and Moritz Schularick, Working Paper 10-937,
October 2009. Available at http://www.hbs.edu/research/pdf/10-037.pdf.
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adjustment. To calculate the level of misevaluation for one country under this method, estimates
of how far exchange rates for every country are out of equilibrium, including countries with
floating exchange rates, must be made.
The main source of contention in FEER estimates is choosing an “equilibrium” current account
balance for each country. Estimates of the RMB’s undervaluation are typically defined as the
appreciation that would be required for China to attain “equilibrium” in its current account
balance. But there is no consensus based on theory or evidence to determine what equilibrium
would be, so a subjective opinion is used.34 Yet this assumption is crucial—Dunaway et al.
demonstrate that changing the assumed equilibrium current account balance by 2 percentage
points of GDP changes the estimated undervaluation by as much as 25 percentage points.35 Some
economists argue that the current account balance would always be close to zero in equilibrium,
but this neglects the fact that countries with different saving and investment rates may willingly
and profitably lend to and borrow from one another for long periods of time. If one uses China’s
neighbors as a reference point, the same combination of large foreign exchange reserves and a
large current account surplus can be seen in several other countries in the region, even though
these countries range in their exchange rate regimes from a float (Japan and South Korea) to a
currency board (Hong Kong). Wang argues that, based on estimates derived from other
developing economies, China’s equilibrium current account surplus may be even larger than the
actual surplus, implying by the FEER method that the RMB is overvalued.36
The other method for estimating the RMB’s undervaluation is based on the theory of purchasing
power parity (PPP)—the theory that the same good should have the same price in two different
countries. If it did not, then arbitrageurs could buy it in the cheaper country and sell it in the more
expensive country until the price disparity disappeared. While PPP is a simple idea that is
theoretically powerful, it has proven to be unreliable in reality: prices are consistently lower in
developing countries than industrialized countries, for example. Some economists have tried to
estimate what the RMB’s value would be by attempting to control for predictable divergences
from PPP. Still, these estimates should be considered with caution—even when sophisticated
modifications have been made, PPP has been shown to help predict exchange rates only over the
long run. Estimates based on PPP would identify any country’s currency as overvalued or
undervalued relative to the country to which it is being compared, regardless of whether the
exchange rate is fixed or floating. Another drawback to the PPP approach is that the estimate will
not tend to change much over time (if prices are relatively stable), even if the trade deficit is
significantly changing.37
The Treasury Department’s December 2006 report to Congress on exchange rates discusses the
use of economic models and methodology to estimate a currency’s “misalignment” or what the
fair market rate exchange rate should be. The report noted that there is no single model that
accurately explains exchange rate movements, that such models rarely, if ever, incorporate
financial market flows, and that their conclusions can vary considerably, based on the variables
34 A thorough attempt to estimate exchange rates using this method can be found in John Williamson, ed., Estimating
Equilibrium Exchange Rates (Washington, DC: Institute for International Economics, 1994).
35 Steven Dunaway et al., “How Robust are Estimates of Equilibrium Real Exchange Rates: The Case of China,” IMF
working paper 06/220, October 2006.
36 Tao Wang, “Exchange Rate Dynamics,” in Eswar Prasad, ed., “China’s Growth and Integration into the World
Economy,” International Monetary Fund, Occasional Paper 232, 2004, Ch. 4.
37 William Cline and John Williamson, “Estimates of the Equilibrium Exchange Rate of the Renminbi,” paper
presented at the Conference on China’s Exchange Rate Policy, Peterson Institute, October 12, 2007.
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used. However, the Treasury Department stated that examining such models can produce useful
information in understanding exchange rate movements if they focus only on serious
misalignments; use real effective, not bilateral, exchange rates; utilize several different models,
recognizing that no one model will provide precise answers; focus only on protracted
misalignments where currency adjustments are not taking place; supplement judgments about
misalignment with analysis of empirical data, indicators, policies and institutional factors; and
verify whether there are any market-based reasons for a currency’s misalignment.38
The two sharply different estimates of the RMB’s undervaluation made by Cline and William in
2010 are a case in point of the challenges posed by economic models. The authors note that they
utilized different methods and assumptions for their two studies, which attempt to determine
fundamental equilibrium exchange rates (FEERs) for various currencies, including the RMB.39
For example, they note that the economic data used for their estimates came from the IMF’s
World Economic Outlook on projections of future economic variables (such as GDP growth and
current account balances). The first study used data from the IMF’s October 2009 Outlook while
the second used the IMF’s April 2010 Outlook. Using different forecast data thus helped produce
widely different results. Because there is no universally accepted methodology for determining a
country’s real market exchange rate, the economic conditions that are used to determine
“equilibrium” exchange rates change continuously, and since estimates of China’s currency
valuation differ so significantly, many analysts question their usefulness to U.S. policymakers in
terms of providing a precise goal for an appreciation of the RMB or for use in trade remedy
legislation that would seek to offset the benefit conferred by the RMB’s undervaluation, such as
in U.S. anti-dumping and countervailing measures.
The Debate over the Effects of Exchange Rate Appreciation on
Trade Flows and the Deficit
Many policymakers might expect that if China significantly appreciated its currency, U.S. exports
to China would rise, imports from China would fall, and the U.S. trade deficit would decline
within a relatively short period of time. For example, C. Fred Bergsten contends that a market-
based RMB would lower the annual U.S. current account deficit by $100 billion to $150 billion.40
But the issue of the possible effects of an RMB appreciation on the U.S. economy is complicated
by the fact that there are short-term and long-term implications of RMB appreciation, and that
exchange rates are but one of many factors that affect trade flows. Other factors affecting the
bilateral trade balance are discussed below.
38 U.S. Treasury Department, Report on International Economic and Exchange Rate Policies, December 2006,
Appendix II.
39 Cline and William define a FEER as “an exchange rate that is expected to be indefinitely sustainable on the basis of
existing policies. It should therefore be one that is expected to generate a current account surplus or deficit that matches
the country’s underlying capital flow over the cycle, assuming that the country is pursuing internal balance as well as it
can and that it is not restricting trade for balance-of-payments reasons.” For China, the authors assume that the
exchange rate should be one consistent with a Chinese current account surplus of no more than 3% of GDP.
40 Correcting the Chinese Exchange Rate: An Action Plan, by C. Fred Bergsten, Peterson Institute for International
Economics, Testimony before the Committee on Ways and Means, US House of Representatives, March 24, 2010.
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The Bilateral Trade Deficit Continued to Grow during the Previous Period of
RMB Appreciation
To illustrate that exchange rates are only one factor that determine trade flows, one can look at the
effect of the 21% RMB appreciation of the RMB to the dollar from July 2005 to July 2008 on
U.S.-China trade flows. On the one hand, during this period U.S. imports from China increased
by 39%, compared to a 92% increase from 2001 to 2004 (when the exchange rate remained
constant).41 On the other hand, U.S. exports to China during the 2005-2008 period did not grow
as fast as during the 2001-2004 period (71% versus 81%).42 Despite the RMB’s appreciation from
2005 to 2008, the U.S. trade deficit with China still rose by 30.1%, although the overall U.S.
current account deficit declined by nearly 6%.43 The appreciation of the RMB appears to have
little effect on China’s overall trade balance from 2005 to 2008. During this time, China’s
merchandise trade surplus increased from $102 billion to $297 billion, an increase of 191%, and
China’s current account surplus and accumulation of foreign exchange reserves both increased by
165% over this period.
The J Curve Effect
Part of the problem in attempting to evaluate the effects of the RMB’s appreciation is that it can
take time (perhaps a few years) before changes in exchange rates are reflected in changes to
prices of tradable goods and services, and hence result in changes to imports, exports, and trade
balances. An appreciated RMB could actually worsen the U.S. trade deficit in the short-run if the
volume (demand) of imports from China did not decline at the same rate that prices increased (the
so-called J-Curve effect). It would take time for U.S. consumers of higher-priced Chinese
products to find lower-priced (non-Chinese) products or other alternatives and thus reduce overall
demand for Chinese imports.44 In addition, there would be a lag time in terms of the effects of an
appreciated RMB on prices of Chinese products, since prices for many exports are set several
months ahead of time in contracts. If an appreciated currency lowered prices for U.S. products, it
could take time for increased Chinese demand to be signaled to U.S. producers and exporters and
for them to boost production to meet the new demand. Over time, one would expect the effects of
currency appreciation to affect the flow of bilateral trade and, possibly, produce a decrease in the
bilateral trade imbalance (although the size of the overall U.S. trade deficit might not change
because that is determined by a number of factors other than exchange rates).
41 Some analysts contend that U.S. imports from China grew rapidly from 2001-2004, and slowed from 2005 to 2008,
not because of the appreciation of the RMB, but because of changes to U.S. consumer demand relating to
macroeconomic conditions.
42 Trade varied from year to year. In 2008, U.S. imports from China rose by 5.1% over the previous year, compared to
import growth of 11.7% in 2007; however, U.S. exports over this period were up 9.5% in 2008 compared with an
18.1% rise in 2007.
43 The current global economic slowdown led to a sharp reduction in U.S.-China trade in 2009; both U.S. exports to and
imports from China fell sharply, though imports fell at a bigger rate. As a result, the U.S. trade deficit with China was
down 14.8% over the previous year.
44 Depending on the elasticity of demand for the product, some might be willing to pay the extra price and buy the same
level as before, some might buy less of the product, and some might stop purchasing the product altogether.
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The Role of Exchange Rate Pass-Through
Another factor to consider in attempting to evaluate the effects of an RMB appreciation on trade
flows is to examine how price changes would be passed on or distributed. If the RMB appreciates
against the dollar, not all of the price increase resulting from the appreciation may be passed on to
the U.S. consumer. Some of it may be absorbed by Chinese laborers, producers, or exporters, and
some by U.S. importers, wholesalers, retailers, etc. According to the U.S. Department of Labor,
from July 2005 to July 2008, the price index for U.S. imports from China rose by 5.2%
(compared to a 13.2% rise in import prices for total U.S. imports of non-petroleum products).45
This would suggest that very little of the price increase that might have resulted from the RMB’s
appreciation was passed on to U.S. consumers.46 If prices are not completely passed through to
consumers, then consumer demand for Chinese imports will fall less than if they were, all else
equal.
China’s Role in the Global Supply Chain
The issue of exchange rate effects is further complicated by China’s role as a major assembly
center for multinational corporations. Many analysts contend that the sharp increase in U.S.
imports from China over the past several years (and hence the growing bilateral trade imbalance)
is largely the result of movement in production facilities from other (primarily Asian) countries to
China. That is, various products that used to be assembled in such places as Japan, Taiwan, Hong
Kong, etc., and then exported to the United States are now being made in China (in many cases,
by U.S. and other foreign firms in China) and exported to the United States. According to Chinese
data, foreign-invested firms in China account for over half of China’s trade flows (both exports
and imports). Such firms import raw materials, intermediate goods (such as components), and
production machinery to China. One study of Apple Inc.’s iPod found that the product itself was
assembled in China in factories owned by a Taiwanese company from components that were
produced by numerous multinational corporations. The level of value added by Chinese workers
who assembled the iPod in China was estimated to be small relative to the total cost of producing
each unit (about 3%), and much smaller relative to the retail price of the unit sold in the United
States.47 Some analysts contend that, because of the high level of imported inputs that comprise a
large share of China’s exports, an appreciated RMB would have little effect on the prices of
Chinese exports, and hence have little effect on bilateral trade flows. Others contend that, even if
foreign-invested firms in China faced significantly higher costs because of an appreciated RMB,
they would move production to another low-cost country, and thus, while the U.S trade deficit
with China decreased, the U.S. trade deficit with other countries would increase.
Underlying Macroeconomic Imbalances Are Unlikely to Disappear
By accounting identity, the overall trade deficit is equal to the shortfall between domestic saving
and investment, while an overall trade surplus is equal to a surplus of domestic saving relative to
investment. For many years, China has been a high-saving country that has run overall trade
45 Bureau of Labor Statistics, Import/Export Price Indexes, Press Release, various issues.
46 Some of the costs may have been borne by Chinese producers or workers. Alternatively, China might have been able
to boost efficiency, thus lowering costs, or production could have moved inland where labor is cheaper.
47 Communications of the ACM, Who Captures Value in a Global Innovation Network? The Case of Apple’s iPod,
March 2009.
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surpluses and the United States has been a low-saving country that has run overall trade deficits
(For more discussion on this issue, see Appendix). China’s use of an exchange rate peg and
capital controls may have contributed to its high saving rate, but it is unlikely that movement to a
floating exchange rate would eliminate the large disparity between U.S. and Chinese saving rates.
Thus, it is likely that the U.S. would continue to be a net debtor and China would continue to be a
net creditor if the RMB rose in value. If so, economic theory predicts the countries’ bilateral trade
imbalance would either persist or possibly be replaced by new bilateral imbalances with third
countries.
Differing Opinions on Making RMB Appreciation a Top U.S. Trade Priority
As noted earlier, a number of U.S. economists have argued that China’s undervalued currency has
negatively affected the U.S. and global economies. However, other economists contend that,
while an undervalued RMB may have distorted trade flows to some extent, it is not the most
significant challenge to U.S. economic interests vis-à-vis China, and therefore, they argue, an
appreciation of the currency by itself would do little to boost the U.S. economy. For example,
• Derek Scissors at the Heritage Foundation contends that appreciation of the RMB
would have little impact on U.S. employment, stating it would create “a few
thousand jobs at best.”48 He argues that the Chinese government’s extensive use
of industrial policies, namely subsidies and regulatory protection (such as state-
sponsored monopolies) sharply limits imports of goods and services that compete
with the state sector, which would remain unaffected even if the RMB was
appreciated. He notes: “Guaranteed revenue and economies of scale make state
firms modestly competitive as exporters when they would otherwise be
uncompetitive. The real harm, however, is to imports of goods and services from
the U.S. The degree of state predominance caps the total share available to all
domestic private and foreign companies, leaving American producers in a vicious
battle for permanently minor market segments. This is a far more stringent
limitation than an undervalued currency.” 49
• Michael Pettis with the Carnegie Endowment for International Peace makes a
similar argument except that he contends that Chinese government “financial
repression” policies have kept real returns to deposits low (and sometimes
negative) in China in order to keep real lending rates artificially low (since they
are set by the government, not market conditions) for Chinese firms (especially
state-owned firms). He states that this constitutes a forced transfer of income
from Chinese households to Chinese producers, which has led to over-investment
and over-capacity by Chinese firms, with much of that excess capacity being
exported. Pettis concludes that “as long as China continues to subsidize its
production growth at the expense of household income, it will have difficulty
increasing domestic demand and cutting its reliance on exports.”50
48 He also argues that reducing the Federal budget deficit in the long run is the best way to boost employment and states
that “in comparative importance, the value of the RMB is a footnote.
49 Heritage Foundation, WebMemo, Deadlines and Delays: Chinese Revaluation Will Still Not Bring American Jobs,
April 6, 2010.
50 Carnegie Endowment for International Peace, How Can China Reduce Its Reliance on Net Exports? June 24, 2010.
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Winners and Losers of RMB Appreciation from an Economic
Perspective
Economists generally oppose the use of polices (such as subsidies and trade protection) that
interrupt market forces and distort the most efficient distribution of resources. A fixed or managed
float exchange rate whose level is not adjusted when economic conditions change might be
viewed as a such a distortion.51 Thus, from an economist’s perspective, adopting a more market-
based currency would be a win-win situation for China, the United States, and the global
economy as a whole, in the sense that it would lead to a more efficient allocation of resources in
both countries (though not necessarily any effect on overall employment levels, as discussed
below). From a policy perspective, it could be argued that China’s current undervalued currency
produces economic “winners and losers” in both countries, and therefore, an adjustment to that
policy would produce a new set of economic “winners and losers.” Although numerous factors
affect global economic growth and trade flows, let us assume that an appreciation of the RMB
produces a significant change in trade. What would the effects be for the U.S. economy?
Effect on U.S Exporters and Import-Competitors
When exchange rate policy causes the RMB to be less expensive than it would be if it were
determined by supply and demand, it causes Chinese exports to be relatively inexpensive and
U.S. exports to China to be relatively expensive. As a result, U.S. exports and the production of
U.S. goods and services that compete with Chinese imports fall, in the short run.52 Many of the
affected firms are in the manufacturing sector.53 This causes the trade deficit to rise and reduces
aggregate demand in the short run, all else equal. A market-based exchange rate could boost U.S.
exports and provide some relief to U.S. firms that directly compete with Chinese firms.
Effect on U.S. Consumers and Certain Producers
According to economic theory, a society’s economic well-being is usually measured not by how
much it can produce, but how much it can consume. An undervalued RMB that lowers the price
of imports from China allows the United States to increase its consumption through an
improvement in the terms-of-trade. Since changes in aggregate spending are only temporary, from
a long-term perspective, the lasting effect of an undervalued RMB is to increase the purchasing
power of U.S. consumers. Imports from China are not limited to consumption goods. U.S. firms
also import capital equipment and inputs from China to produce finished goods. An undervalued
RMB lowers the price of these U.S. products, increasing their output, and thus making such firms
more internationally competitive. An appreciation of China’s currency could raise prices for U.S.
51 The standard economic model for determining whether countries should have a floating exchange rate is the “optimal
currency area” model. According to this model, two countries can gain from fixed exchange rates if their goods and
labor markets are highly interconnected and their business cycles are closely synchronized. By these criteria, China and
the United States are unlikely to form an optimal currency area.
52 Many such firms contend that China’s currency policy constitutes one of several unfair trade advantages enjoyed by
Chinese firms, including low wages, lack of enforcement of safety and environmental standards, selling below cost
(dumping) and direct assistance from the Chinese government.
53U.S. employment in manufacturing as a share of total non-agricultural employment fell from 31.8% in 1960, to 22.4%
in 1980, to 13.1% in 2000, to 9.1% in December 2009. This trend is much larger than the Chinese currency issue and is
caused by numerous other factors, including productivity gains in manufacturing and the rise of employment in the
service sector.
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consumers, lowering their economic welfare, meaning they have less money to spend on other
goods and services. In addition, firms that use imported Chinese parts could face higher costs,
making them relatively less competitive.
Effect on U.S. Borrowers
An undervalued RMB also has an effect on U.S. borrowers. When the United States runs a
current account deficit with China, an equivalent amount of capital flows from China to the
United States, as can be seen in the U.S. balance of payments accounts. This occurs because the
Chinese central bank or private Chinese citizens are investing in U.S. assets, which allows more
U.S. capital investment in plant and equipment to take place than would otherwise occur. Capital
investment increases because the greater demand for U.S. assets puts downward pressure on U.S.
interest rates, and firms are now willing to make investments that were previously unprofitable.
This increases aggregate spending in the short run, all else equal, and also increases the size of
the economy in the long run by increasing the capital stock. The effect on interest rates is likely to
be greater during periods of robust economic growth, when investment demand is strong, than
when the economy is weak.
Private firms are not the only beneficiaries of the lower interest rates caused by the capital inflow
(trade deficit) from China. Interest-sensitive household spending, on goods such as consumer
durables and housing, is also higher than it would be if capital from China did not flow into the
United States. In addition, a large proportion of the U.S. assets bought by the Chinese,
particularly by the central bank, are U.S. Treasury securities, which fund U.S. federal budget
deficits. According to the U.S. Treasury Department, China held $902 billion in U.S. Treasury
securities as of April 2010, making it the largest foreign holder of such securities and accounting
for 23% of total foreign holdings. The U.S. federal budget deficit has increased rapidly since
FY2008, causing a sharp increase in the amount of Treasury securities that must be sold. While
the Obama Administration has pushed China to appreciate its currency, it has also encouraged it
to continue to purchase U.S. securities. Some analysts contend that, although an appreciation of
China’s currency could help boost U.S. exports to China, it could also lessen China’s need to buy
U.S. Treasury securities, which could push up U.S. interest rates. In the unlikely worst case
scenario, if China stopped buying Treasury securities at a time when the U.S. budget deficit is
unusually high, it could destabilize financial markets by throwing into doubt the U.S.
government’s ability to sustain its current fiscal policy.
Net Effect on the U.S. Economy
In the medium run, according to economic theory, an undervalued RMB neither increases nor
decreases aggregate demand in the United States. Rather, it leads to a compositional shift in U.S.
production, away from U.S. exporters and import-competing firms toward the firms that benefit
from Chinese capital flows. Thus, it is expected to have no medium- or long-run effect on
aggregate U.S. employment or unemployment. As evidence, one can consider that the since the
1980s, the U.S. trade deficit has tended to rise when unemployment was falling and fall when
unemployment is rising. For example, the current account deficit peaked at 6% of GDP in 2006,
when the unemployment rate was 4.6%, and fell to 3% of GDP in 2009, when the unemployment
rate was 9.3%.
However, the gains and losses in employment and production caused by the trade deficit will not
be dispersed evenly across regions and sectors of the economy: on balance, some areas will gain
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while others will lose. And by shifting the composition of U.S. output to a higher capital base, the
size of the economy would be larger in the long run as a result of the capital inflow/trade deficit
(although the returns from foreign-financed capital will not flow to Americans).
Although the compositional shift in output has no negative effect on aggregate U.S. output and
employment in the long run, there may be adverse short-run consequences. If U.S. output in the
trade sector falls more quickly than the increases in output of U.S. recipients of Chinese capital,
aggregate U.S. spending and employment could temporarily fall. This is more likely to be a
concern if the economy is already sluggish than if it is at full employment. Otherwise, it is likely
that government macroeconomic policy adjustment and market forces can compensate for any
decline of output in the trade sector by expanding other elements of aggregate demand. The U.S.
trade deficit with China (or with the world as a whole) has not prevented the U.S. economy from
registering high rates of growth in the past.
A Yale University study estimated that a 25% appreciation of the RMB would initially decrease
U.S. imports from China and lead to greater domestic production in the United States and
increased exports to China. However, the study estimated that benefits to the U.S. economy
would be offset by lower Chinese economic growth (because of falling exports), which would
diminish its demand for imports, including those from the United States. In addition, the RMB
appreciation would increase U.S. costs for imported products from China (decreasing real wealth
and real wages), and cause higher U.S. short-term interest rates. As a result, the sum effect of the
25% RMB appreciation was estimated to a negative effect on U.S. aggregate demand and output
and result in a loss of 57,100 U.S. jobs—less than one-tenth of 1% of total U.S. employment.54
China’s Perspective and Concerns: Economic
Growth and Stability
Chinese officials argue that their currency policy is not meant to favor exports over imports, but
instead to foster economic stability through currency stability. The policy reflects the
government’s goals of using exports as a way of providing jobs to Chinese workers and to attract
FDI in order to gain access to technology and know-how. The Chinese government has stated on
a number of occasions that currency reform is a long-term goal which will implemented
gradually. Officials have strongly condemned international pressure to induce China to appreciate
the currency, arguing that it interferes with China’s “sovereignty” to implement its own domestic
economic policies. In December 2009, China’s media reported unnamed government officials as
stating that “it would be difficult to make the case of an immediate renminbi appreciation in a
country where 40 million people live on less than 1 U.S. dollar a day.”55 It also reported Chinese
Premier Wen Jiabao stating that “some countries demand the yuan’s appreciation, while
practicing various trade protectionism against China. It’s unfair and actually limits China’s
development.”56
54 Fair, Ray C., “Estimated Macroeconomic Effects Of A Chinese Yuan Appreciation,” Cowles Foundation Discussion
Paper 1755, March 2010.
55 Xinhua News Agency, December 1, 2009.
56 Ibid.
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Despite the Chinese government’s recent pledges on currency reform, it has moved somewhat
cautiously. In addition, Chinese officials have sharply rejected assertions that China’s currency
policy undermines the global economy or that a sharp appreciation of the RMB is need to boost
global economic recovery. In addition, they have argued that promoting rapid domestic growth,
rather than appreciating the currency, is the most significant policy China can undertake to
promote global economic recovery. They note that during the first nine months in 2010, Chinese
merchandise imports have risen by 42.2% over the same period in 2009, compared with a 34.0%
rise in merchandise exports, and monthly surpluses are less than they were in pre-crisis levels (see
Figure 5). China’s trade surplus from January-September 2010 was down 11.7% over the same
period in 2009. In addition, China experienced a trade deficit in March 2010, the first such
monthly deficit in six years. Chinese officials contend that the rapid growth in imports proves that
the currency policy does not restrict trade or promote Chinese economic growth at the expense of
other countries. Critics counter that China’s exports have grown rapidly over the past few months,
rising to the levels that occurred prior to the global economic slowdown, and that China’s trade
surplus appears to be picking up as well, thus justifying a faster appreciation of the RMB.
Chinese officials view economic growth as critical to sustaining political stability, and thus
appear very reluctant to implement policies that might disrupt the economy and cause widespread
unemployment, which could cause worker unrest.57 They note that the global financial crisis had
a significant impact on China’s trade and FDI flows. For example, from January to September
2008, China enjoyed nearly double-digit growth in monthly exports, imports, and FDI on a year-
on-year basis. However, China’s year-on-year exports and imports dropped for 11 consecutive
months from November 2008 to October 2009, and FDI declined 9 consecutive months from
October 2008 to July 2009. For the full year in 2009, Chinese exports, imports, and FDI declined
by 15.9%, 11.3%, and 2.6%, respectively, over 2008 levels. As a result, thousands of export-
oriented factories reportedly were shut down and over 20 million migrant workers reportedly lost
their jobs in 2009 because of the direct effects of the global economic slowdown. Although China
has been able to weather the global economic slowdown through enactment of a $586 billion
stimulus program and a loose monetary policy, which helped produce real GDP growth of 9.1%
in 2009, the government remains concerned whether it can continue to effectively manage the
economy and achieve fast rates of growth in the years ahead.
57 There have been numerous reports of labor unrest and strikes in different parts of China in 2010, mainly over pay
issues. Chinese officials are concerned that an appreciation of the RMB could induce Chinese export producers to try to
hold down wages to remain competitive, or could force them out of business, which could lead to more job losses and
provoke more unrest.
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Figure 5. China’s Monthly Trade Flows: January 2008-September 2010
$millions
Source: Global Trade Atlas using official Chinese statistics.
The Effects of an Undervalued RMB on China’s Economy
If the RMB is undervalued vis-à-vis the dollar, then Chinese exports to the United States are
likely cheaper than they would be if the currency were freely traded, providing a boost to China’s
export industries, and helping to make it the world’s largest merchandise exporter. Eliminating
exchange rate risk through a managed peg also increases the attractiveness of China as a
destination for foreign investment in export-oriented production facilities. However, there are a
number of negative aspects to China’s export growth strategy and currency policy.
• Overdependence on exporting (and fixed investment relating to exports) and FDI
inflows made China particularly vulnerable to the effects of the global economic
slowdown. Analysis by the IMF estimated that fixed investment related to
tradable goods plus net exports together accounted for over 60% of China’s GDP
growth from 2001 to 2008, (up from 40% from 1990 to 2000), which was
significantly higher than in the G-7 countries (16%), the euro area (30%) and the
rest of Asia (35%). GDP growth in China fell from 13% in 2007 to 8.7% in 2009,
still one of the fastest growth rates in the world.58
• An undervalued currency makes imports more expensive, hurting Chinese firms
that import parts, machinery, and raw materials. Such a policy, in effect, benefits
Chinese exporting firms (many of which are owned by foreign multinational
corporations) at the expense of non-exporting Chinese firms. This may impede
the most efficient allocation of resources in the Chinese economy. Resources that
58 Guo, Kai and Papa N’Diaye, Is China’s Export-Oriented Growth Sustainable, IMF Working Paper, August 2009.
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might go to other sectors, such as the service sector, are diverted to the export
sector.
• If one considers an undervalued currency as a form of export subsidy, then
China, in effect, is subsidizing American living standards by selling products that
are cheaper than they would be under market conditions. This in effect lowers
China’s terms of trade—the level of imports that can be obtained through
exports. Chinese citizens on the other hand pay more for tradable goods, not only
because imported goods are more expensive because of the de facto tariff an
undervalued currency entails, but also because domestic competition is restricted
as well. Rather than use its trade surpluses to purchase goods and services from
abroad, China is forced, because of its need to maintain its peg to the dollar, to
put a large share of its foreign exchange holdings into U.S. debt securities, which
earn a relatively low return.
• The use of a pegged system effectively limits the ability of the central
government to use monetary policy to control inflation. If the government raised
interest rates, “hot money” would flow to China from abroad, forcing the
government to increase the money supply to buy up the foreign currency
necessary to maintain the targeted peg, which has often lead to easy credit
policies by the banks, resulting in overcapacity in a number of sectors, such as
steel, and speculative asset bubbles, such as in real estate.59 As a result, the
Chinese government has tried to use administrative controls, with limited results,
to limit bank loans to sectors where overcapacity is believed to exist.
Although a rebalancing of China’s economy, including the adoption of a market-based currency,
would likely entail significant adjustment costs, it would also likely produce long-term benefits to
the Chinese economy. For example it could:
• boost China’s term of trade by increasing the level of imports that can be
purchased by its exports;
• increase economic efficiency (and hence economic growth), by re-directing
resources away from inefficient (and often subsidized) sectors of the economy to
those that are more efficient and competitive;
• lower prices for imported goods and services and expose more of the domestic
economy to greater global competition, thus lowering prices for consumers and
improving Chinese living standards;
• improve the efficiency and competiveness of many Chinese domestic firms
(including those that produce only for the domestic market) by lowering prices
for imported inputs, raw materials, and machinery, thus boosting their output;
• expand the ability of the government to use monetary policies to control inflation
and to allocate capital according to its most efficient use through a market-based
credit system;
• help alleviate the large disparities of economic development between the coastal
regions of China (as well as growing income disparities throughout China) that
59 The government can and has attempted to sterilize the increase of the money supply by forcing state banks to buy
and hold government bonds.
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have been driven in part by China’s export growth strategy and are viewed by
many analysts as posing a potential risk to stability;
• help reduce or eliminate a major source of tension between China and many of its
trading partners, some of whom view China’s undervalued currency and its use
of subsidies as beggar-thy-neighbor policies that promote economic development
in China at the expense of growth in other countries.
The great challenge for Chinese leaders, assuming that they are committed to greater economic
reform and rebalancing the economy (and there is no clear evidence indicating whether or not
they are), would be to quickly generate new sources of economic growth and job opportunities in
order to offset the decline of those sectors that would no longer be able to compete once
preferential government policies (such as subsidies and an undervalued currency) are eliminated.
However, some analysts contend that this rebalancing could prove difficult for China politically
and could take several years to achieve. For example, according to Michael Pettis, reforming
China’s economic policies would have to involve political reforms because “eliminating the
mechanisms by which Chinese policymakers can transfer income from households to
manufacturers will reduce their control over the commanding heights of the economy, and it will
sharply reduce the power and leverage the ruling party has over business and local
governments.”60 On the other hand, China’s economy has consistently generated annual growth
rates near 10% in recent decades, making adjustment much easier.
Policy Options for the RMB and Potential Outcomes
If the Chinese were to allow their currency to float, it would be determined by private actors in
the market based on the supply and demand for Chinese goods and assets relative to U.S. goods
and assets. If the RMB appreciated as a result, this would boost U.S. exports and the output of
U.S. producers who compete with the Chinese. The U.S. bilateral trade deficit would likely
decline (but not necessarily disappear). At the same time, the Chinese central bank would no
longer purchase U.S. assets to maintain the peg. U.S. borrowers, including the federal
government, would now need to find new lenders to finance their borrowing, and interest rates in
the United States would rise. This would reduce spending on interest-sensitive purchases, such as
capital investment, housing (residential investment), and consumer durables. The reduction in
investment spending would reduce the long-run size of the U.S. capital stock, and thereby the
U.S. economy. In the present context of a large budget deficit, some analysts fear that a sudden
decline in Chinese demand for U.S. assets (because China was no longer purchasing assets to
influence the exchange rate) could lead to a drop in the value of the dollar that could potentially
destabilize the U.S. economy.61
If the relative demand for Chinese goods and assets were to fall at some point in the future, the
floating exchange rate would depreciate, and the effects would be reversed. Floating exchange
rates fluctuate in value frequently and significantly.62
60 Pettis, Michael, Sharing the Pain: The Global Struggle Over Savings, Carnegie Endowment for International Peace,
November 2009, p. 7.
61 For more information, see CRS Report R40770, Economic Effects of a Budget Deficit Exceeding $1 Trillion, by
Marc Labonte.
62 Some economists argue that short-term movements in floating exchange rates cannot always be explained by
economic fundamentals. If this were the case, then the floating exchange rate could become inexplicably overvalued
(continued...)
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A move to a floating exchange rate is typically accompanied by the elimination of capital controls
that limit a country’s private citizens from freely purchasing and selling foreign currency. The
Chinese government maintains capital controls (and arguably one of the major reasons China
opposes a floating exchange rate) because it fears a large private capital outflow would result if
such controls were removed. This might occur because Chinese citizens fear that their deposits in
the potentially insolvent state banking system are unsafe. If the capital outflow were large
enough, a banking crisis in China could result and could cause the floating exchange rate to
depreciate rather than appreciate.63 If this occurred, the output of U.S. exporters and import-
competing firms would be reduced below the prevailing level, and the U.S. bilateral trade deficit
would likely expand. In other words, the United States would still borrow heavily from China, but
it would now be private citizens buying U.S. assets instead of the Chinese central bank. China
could attempt to float its exchange rate while maintaining its capital controls, at least temporarily.
This solution would eliminate the possibility that the currency would depreciate because of a
private capital outflow. While this would be unusual, it might be possible. It would likely make it
more difficult to impose effective capital controls, however, since the fluctuating currency would
offer a much greater profit incentive for evasion.
Another possibility is for China to maintain the status quo. Even without adjustment to the
nominal exchange rate, over time the real rate would adjust as inflation rates in the two countries
diverged. The Chinese central bank acquires foreign reserves by printing yuan to finance its trade
surplus. As the central bank exchanged newly printed yuan for U.S. assets, prices in China would
rise along with the money supply until the real exchange rate was brought back into line with the
market rate.64 This would cause the U.S. bilateral trade deficit to decline and expand the output of
U.S. exporters and import-competing firms. This real exchange rate adjustment would only occur
over time, however, and pressures on the U.S. trade sector would persist in the meantime.
None of the solutions guarantee that the bilateral trade deficit will be eliminated. China is a
country with a high saving rate, and the United States is a country with a low saving rate; it is not
surprising that their overall trade balances would be in surplus and deficit, respectively. As the
Appendix discusses, many economists believe that these trade imbalances will persist as long as
underlying macroeconomic imbalances persist. At the bilateral level, it is not unusual for two
countries to run persistently imbalanced trade, even with a floating exchange rate. If China can
continue its combination of low-cost labor and rapid productivity gains, which have been
reducing export prices in yuan terms, its exports to the United States are likely to continue to
grow regardless of the exchange rate regime, as evidenced by the 21% appreciation of the RMB
from 2005 to 2008 which did not lead to any reduction in the trade deficit over that period.
(...continued)
(undervalued) at times, reducing (increasing) the output of U.S. exporters and U.S. firms that compete with Chinese
imports. These economists often favor fixed or managed exchange rates to prevent these unexplainable fluctuations,
which they argue are detrimental to U.S. economic well-being. Other economists argue that movements in floating
exchange rates are rational, and therefore lead to economically efficient outcomes. They doubt that governments are
better equipped to identify currency imbalances than market professionals.
63 This argument is made in Morris Goldstein and Nicholas Lardy, “A Modest Proposal for China’s Renminbi,”
Financial Times, August 26, 2003. Alternatively, if Chinese citizens proved unconcerned about keeping their wealth in
Chinese assets, the removal of capital controls could lead to a greater inflow of foreign capital since foreigners would
be less concerned about being unable to access their Chinese investments. This would cause the exchange rate to
appreciate.
64 To some extent, China can reduce the effects of the accumulation of foreign reserves on the money supply through
credit controls, although this is unlikely to be completely effective.
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Appendix. Indicators of U.S. and Chinese Economic
Imbalances
The issue of rebalancing economic growth by both the United States and China has been a central
focus of the U.S.-China Strategic and Economic Dialogue (S&ED) talks held in July 2009 and
May 2010. Secretary of Treasury Timothy Geithner stated at the July 2009 S&ED that:
“Recognizing that cooperation between China and the United States will remain vital not only to
the well being of our two nations but also the health of the global economy, we agreed to
undertake policies to bring about sustainable, balanced global growth once economic recovery is
firmly in place.”
The global financial crisis and subsequent GDP decline among many countries have resulted in
new scrutiny by many economists of “global imbalances,” namely the disparities in savings and
investment levels among various countries (i.e., some countries save too little and some too much
relative to their investment needs), and subsequent current account imbalances that have resulted
(i.e., countries where domestic savings exceed investment run trade surpluses and countries
where domestic investment exceeds saving run current account deficits). China and the United
States are not unique in having these imbalances—Japan, Germany, and other East Asian
countries are other examples of high savers, while southern and eastern European countries are
other examples of high borrowers. Nevertheless, the United States and China have come under
particular scrutiny because of their relative overall size (they are projected to be the two largest
economies in the world in 2010) and the relative size of their saving, investment, and trade
imbalances. Some analysts also claim that China’s exchange rate policy is preventing other East
Asian countries from adjusting, because those countries are unwilling to allow their currencies to
appreciate and lose export market share to China unless the RMB appreciates too.
Many economists contend such imbalances were a major cause of the current global economic
slowdown. For example, high savers, such as China, loaned their money to low savers, such as
the United States, which helped keep real U.S. interest rates low and contributed to the bubble in
the U.S. housing market and subsequent financial crisis. Many of the high savings countries
(especially those in Asia) heavily relied on exporting as a source of their economic growth and
thus were significantly impacted when global demand for imports sharply fell.65 As a result, many
economists have called for economic restructuring among many of the world’s major economies,
especially the United States and China. Fundamental restructuring of this sort would take time,
and if not well coordinated, could deepen the global output gap in the short run. For example, if
low saving countries attempt to increase their saving rate (e.g., by reducing their government
budget deficits) at a time of high unemployment, and high saving countries do not simultaneously
increase their consumption, then worldwide demand could decline and cause unemployment to
rise further in the short run.
This section provides an overview of some of the unique differences between the economies of
the United States and China that have played a role in global imbalances.
65 For an overview of this argument, see Blanchard, Olivier and Gian Maria Milesi-Ferretti, “Global Imbalances: In
Midstream?” IMF Staff Position Note, December 22, 2009.
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Current Account Balances, Savings, and Investment
The level of U.S. gross savings is far below total U.S. investment, indicating that the U.S. must
borrow capital abroad to meet its investment needs. By definition, domestic savings minus gross
investment (from domestic and foreign sources) equals the current account balance.66 Nations that
do not save enough to meet domestic investment needs run current account deficits and those that
save more than they need for domestic investment run current account surpluses.67 In 2008, the
ratio of U.S. gross domestic savings to gross investment in 2008 was 66.9%, the lowest among
the world’s major economies. On the other hand, the ratio for China was 122.2% (see Table A-1).
Table A-1. Ratio of Gross National Savings to Gross Investment and Current
Account Balances as a Percent of GDP for Various Economies: 2008
Gross National Savings/Gross
Current Account Balance/GDP
Investment (%)
(%)
United States
66.9
-4.9
Italy 84.1
-3.4
Australia 84.6
-4.6
France 89.8
-2.2
United Kingdom
91.0
-1.5
Brazil 91.5
-1.5
India 93.1
-2.4
Mexico 94.5
-1.5
South Korea
95.2
-0.7
Thailand 99.9
0.0
Indonesia 100.4
0.1
Canada 102.2
0.5
Japan 113.6
3.2
China 122.2
9.6
Russia 124.2
6.2
Taiwan 127.5
6.2
Germany 134.5
6.6
Singapore 163.9
14.4
Malaysia 191.8
17.6
Source: Economist Intelligence Unit.
Note: The current account data for most of the countries changed significantly in 2009 as a result of the global
financial crisis.
66 The current account balance is the broadest measurement of a country’s financial flows. It includes the balances for
trade in goods and services, net income (investment income and compensation for overseas workers), and net unilateral
transfers.
67 A current account deficit also reflects that a country consumes more than it produces, while a current account surplus
indicates that a countries produces more than it consumes.
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In nominal dollar terms, the United States had the world’s largest current account deficit at $706
billion in 2008, while China had the largest current account surplus at $426 billion (see Figure A-
1 ).68 These balances were also significant as a share of GDP: 9.6% for China and -4.9% for the
United States (see Figure A-2).69
Figure A-1. Chinese and U.S. Current Account Balances: 2000-2009
$billions
Source: Global Insight.
68 The U.S. current account deficit, and China’s current account surplus, both fell in 2009 as a result of the global
economic slowdown.
69 The U.S. current account deficit as a percent of GDP fell in 2008 and 2009. China’s current account surplus as a
percent of GDP fell each year from 2007 to 2009.
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Figure A-2. Chinese and U.S. Current Account Balances as a Percent of GDP:
2000-2009
(%)
Source: Global Insight.
Gross savings are the total level of domestic savings, including private, corporate, and
government. Savings represents income that is not consumed. Physical investment spending on
plant and equipment can be financed from domestic or foreign savings. Over the past several
years, the United States has maintained one of the lowest gross savings rates (i.e., total national
savings as a percent of GDP) among developed countries, while China has maintained one of the
world’s highest national savings rates. From 1990 to 2009, U.S. gross national savings as a
percent of GDP declined from 13.5% to 8.7%, while China’s rose from 37.8% to 50.5% (see
Figure A-3).
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Figure A-3. Gross National Savings as a Percent of GDP for China and the United
States: 1990-2009
(% )
Source: Economist Intelligence Unit.
Notes: Aggregate national savings by the public and private sector as a percentage of nominal GDP.
Some “rebalancing” has taken place during the global recession. The U.S. current account deficit
has declined from 6% to 3% of GDP between 2006 and 2009. It has fallen because domestic
investment spending has fallen and the private saving rate has risen from 14% of GDP in 2007 to
17% of GDP in 2009. On the other hand, this rebalancing has been partly offset by the increase in
the U.S. budget deficit from 1.2% of GDP in 2007 to 9.9% of GDP in 2009, which directly
reduces national saving. What remains to be seen is how much of this rebalancing is cyclical, and
will be reversed when the U.S. economy improves, and how much of it is permanent. China’s
current account surplus fell from 10.8% of GDP in 2007 to 5.8% of GDP in 2009.
Despite the rebalancing that has already taken place, some economists would not consider either
country to have reached a position that is sustainable in the long run. Before the late 1990s, the
United States had never had a current account deficit of 3% of GDP. And even with China’s
reduced current account surplus, and the diminished U.S. current account deficit over the past few
years, China’s net holdings of foreign assets and the U.S. net foreign debt continue to grow.
Likewise, the decline in China’s current account surplus was caused by a more rapid decline in
China’s exports than imports during the worldwide economic downturn—when worldwide
growth picks up again and reaches pre-crisis levels, that trend could reverse. Global demand for
Chinese products (despite economic slowdowns in many countries) has increased sharply over the
past few months.
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Sources of Economic Growth
Figure A-4 and Figure A-5 indicate sources of real GDP growth for the United States and China
from 2003-2009. From 2003 to 2007, the largest source of U.S. GDP growth was private
consumption. In 2008 and 2009, changes in external balances (i.e., net exports) were the fastest
growing sector of the U.S. economy. For China, gross fixed investment (much of it linked to
tradable sectors for most years) was the largest contributor to its GDP growth from 2003-2009. In
2009, changes to net exports in China were a drag on the Chinese economy.
Figure A-4. U.S. Real GDP Growth and Sources of GDP Growth: 2003-2009
(% and % Points)
Source: Economist Intelligence Unit.
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Figure A-5. Chinese Real GDP Growth and Sources of GDP Growth
(% and % Points)
Source: Economist Intelligence Unit.
Investment and Consumption Relative to GDP
As indicated in Figure A-6, China’s gross investment as a percent of GDP in 2008 was the
highest of any major economy at 43.5% in 2008, up from 34.3% in 2000. In comparison, the U.S.
total in 2008 was 14.8%, the lowest among the countries listed. Conversely, as indicated in
Figure A-7, China had one of the lowest rates of private consumption among major economies at
35.5%, which was down from 46.5% in 2000. In comparison U.S. private consumption as a share
of GDP in 2008 was 70.1%, among the highest of major economies.
Although the level of Chinese private consumption is small relative to GDP, it is rapidly growing.
From 2000 to 2009, real Chinese private consumption grew at an average annual rate of 7.1%,
which was much faster than the growth in real U.S. private consumption, but slower than the
overall growth rate of the economy (see Figure A-8).
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China’s Currency: An Analysis of the Economic Issues
Figure A-6. Gross Investment as a Percent of GDP for Selected Economies: 2008
(%)
Source: Economist Intelligence Unit.
Figure A-7. Private Consumption as a Percent of GDP for Selected Economies: 2008
(%)
Source: Economist Intelligence Unit.
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China’s Currency: An Analysis of the Economic Issues
Figure A-8.Annual Growth in Real Chinese and U.S. Private Consumption:
2000-2009
% Increase over the previous year
Source: Economist Intelligence Unit.
Author Contact Information
Wayne M. Morrison
Marc Labonte
Specialist in Asian Trade and Finance
Specialist in Macroeconomic Policy
wmorrison@crs.loc.gov, 7-7767
mlabonte@crs.loc.gov, 7-0640
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