Chinese Currency and Economic Policy

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China’s policy of limiting the appreciation of the renminbi (RMB), its currency, is a source of tension between the United States and China. China has been accused of manipulating its currency to obtain advantages over trading partners. Some charge that China’s currency manipulation impacts U.S. trade deficits with China and leads to the loss of U.S. jobs. In 2010 President Obama expressed his concern that China’s policy puts U.S. firms at a great disadvantage. 

In additional to China’s currency policies designed to compete with the dollar, China is making moves to compete with the IMF and the World Bank. China is spearheading BRICS an economic alliance between Brazil, Russia, India, China, and South Africa. BRICS hopes to boost the economic power of Eastern countries and Challenge the economic dominance of the West. This paper examines China’s currency policy, its involvement in BRICS, and its recent attempts to revive its own economy.  

Economic Reform in China

In July of 2005 China began to reform its currency policy. In between 2005 and 2013 there was a 34% appreciation of the RMB. Since China adjusted its currency policy its trade policies have been dwindling. Additionally, China’s accumulation of exchange reserves from other countries has slowed down. Recent developments with the RMB has led some to assert that the relationship between the RMB and the dollar is approaching market value. In spite of these developments some analysts still view the RMB as undervalued in comparison to the dollar. 

Economist Views

There are economists that assert both positive and negative effects on the U.S. economy resulting from China’s manipulated RMB. However, most economists believe that if China allows the market to determine the value of the RMB it will be better for the worldwide economy. Additionally some argue that reforming currency policy is the long term interests of China as well.

Arguments in Favor of China's Policy

Some economists argue that if the Chinese RMB appreciates the cost of Chinese products would rise and this could hurt U.S. consumers. Other outcomes of an appreciating RMB could be that the Chinese government purchases less U.S. Treasury securities. Others argue that changes to the Chinese RMB would do little to impact the manufacturing conducted by foreign invested firms. Some analysts believe that if the U.S. wants China's economy balanced, the U.S. should work to convince China to create circumstances that increase consumer demand.

Background on China’s Currency Policy

China had a dual exchange rate system before 1994. The system consisted of a market based exchange rate system used by importers and exporters and a fixed system used by the government. The rates used by importers and exporters varied significantly from the system used by the government. “The official exchange rate with the dollar in 1993 was 5.77 yuan versus 8.70 yuan in swap markets” . The dual exchange system was unified by the Chinese government in 1994. China fixed the RMB to the U.S. dollar at 8.28 yuan until 2005. Economists say that the move was made to encourage investment in China and stabilize foreign trade. Because of China’s linking the yuan to the dollar outside factors that would have caused the yuan to appreciate were irrelevant. Under a market system demand for each country's assets and goods would determine the exchange rate. 

Reforms of 2005 

On July 21 of 2005 the Chinese government announced that the RMB exchange rate would be based on market supply and demand. The RMB was allowed to change by up to 0.3% and later up to 0.5%. Beginning in July of 2005 the RMB was allowed to appreciate slowly. However, in 2008 China halted the appreciation of the RMB. The move came as a result of a decrease in demand for Chinese products due to the worldwide financial crisis. China reported a 15.9% decrease in exports and 20 million jobs lost do to the crisis in 2009. Due to the economic crisis China intervened and stopped the appreciation of the RMB. 

2010 Appreciation Resumes 

In June of 2010 the Chinese government resumed the appreciation of the RMB. While the Chinese Central Bank claims that the change was due to new economic conditions others claim the move was due to new economic conditions, others claim the move was to avoid the RMB being the focus of the G20 summit conference held in Toronto that month. From June of 2010 to July of 2013 the yuan/dollar exchange appreciated 10.7%. 

Factoring in Inflation

A number of economists have proposed that the real way to measure the exchange rate between the RMB and the dollar is to factor in inflation in both countries. For example if inflation is occurring in China then this could serve as a defacto appreciation. Indeed China's consumer price inflation was 31% higher than the U.S. level from June of 2005 to June of 2013. By factoring inflation into the exchange rate between Chinese and U.S. currencies the RMB appreciated by 42% between 2005 and 2013. 

U.S. Criticism of China’s Currency Policy

The accusation has come from U.S. policymakers and labor representatives that Chinese officials undervalued the RMB in relation to the U.S. dollar so that Chinese exports to the U.S. would be more affordable. Additionally they charge that the Chinese government's manipulation of the RMB made U.S. exports to China more expensive and contributed to the U.S. trade deficit with China. This may have some merit as the U.S. trade deficit grew from $84 billion in 2000 to $315 billion in 2012. 

Critics have also pointed to China’s accumulation of foreign exchange reserves. Some economic analysts argue that the “large increases in China’s foreign exchange reserves reflect the significance of Chinese intervention in currency markets to hold down the value of the RMB” . An economist estimated that a nation's account balance could increase 60 to 100 cents per every dollar spent to intervene in currency issues. 

RMB and U.S. Deficit

One of the reasons that some in the U.S. have expressed concerns about the manipulation of the RMB is the high U.S. unemployment rate. Some critics of Chinese policy assert that the appreciation of RMB would create more jobs in the U.S. Additionally some say that there is a relation between the U.S. trade deficit and the loss of jobs in the United States. Indeed a study by the Economic Policy Institute asserts that from 2001 to 2011 the trade deficit with China costs the United States economy 2.7 million jobs. Those that note the negative impact of China’s RMB manipulation on the U.S. economy also note the rapid growth of the Chinese economy during the same years. Furthermore, U.S. economist Paul Krugman argues that China’s policies have hurt the global recovery. 

Legislative Proposals to Address Undervalued Currencies 

Over the last decade there have been many legislative attempts to put pressure on the Chinese to Change their economic policy. In the 108th Congress, Senator Schumer introduced legislation that would have placed an additional 27.5% on Chinese exports unless China changed its policy. During the 111th Congress and the 112th Congress the House and the Senate passed measures to influence China's currency policy respectively. However, neither bill eventually became law. One of the goals of the proposed currency bills was to alter U.S. Trade laws that say the U.S. Treasury has the responsibility to identify countries that intentionally manipulate their currency, 1994 was the last time that the U.S. Treasury did that. Certain bills have sought to change the Treasury’s responsibility to have to identify when foreign currencies are misaligned with the U.S. dollar. Under the proposed system it won't matter why a currency is misaligned this will make the U.S. Treasury taking action less politically controversial. Those that support legislative proposals hope that currency bills will put pressure on China to appreciate its currency more swiftly. However, others argue that legislation seeking to address currency misalignment could antagonize the Chinese government. Another concern of some U.S. lawmakers is that China may retaliate against U.S. exports. 

The Currency Exchange Rate Oversight Reform Act of 2013

Introduced by Senator Sherrod Brown the Currency Exchange Rate Oversight Reform Act sought to identify currencies misaligned with the U.S. dollar. Additionally, the bill would have required a semiannual report from the U.S. Treasury on exchange rate and monetary policy. The Treasury report would do six things: 1) detail all currency interventions by The U.S. or major trading partners, 2) evaluate domestic and international factors that impact currencies, 3) determine which economies with major trade flows to the U.S.  4) identify currencies for priority action, 5) identify the value related to medium-term equilibrium rates in relation to the U.S. dollar for all of the currencies labeled for priority action and 6) detail any action taken to halt misalignment . The bill required the Treasury to attempt negotiation with all countries identified for priority action. Four items were identified that could place a country on the priority action list. 

The first thing that could place a nation on the priority action list would be large scale interventions in the market. Another action that could place a country on the priority list is extended and excessive accumulation of foreign exchange reserves used for balance of payment. A third way to be placed on the priority action list is modifying incentives or restrictions on capital inflows and outflows that are not consistent with achieving total currency convertibility. The fourth way is to be engaged in economic action deemed by the Treasury Department as leading to currency misalignment. 

The bill required very specific action to be taken by the U.S. government if countries identified for priority action did not eliminate policy misalignment within 90 days. The following are the actions the bill would require from the U.S. government: 1) The commerce department would be required to factor in the estimated level of currency undervaluation when looking at export prices compared to normal price; 2) the president would have to prevent the federal government for obtaining goods or services from a country unless it is a member of the WTO Government procurement agreement; 3) the Overseas Private Investment Corporation would not be allowed to approve new financing on projects in the violating country; 4) the U.S. Executive Director at all multinational bank would be instructed to oppose new financing to the violating countries government or projects in that country; and 5) the U.S. government would ask the IMF to conduct special sessions with a violating country to eliminate currency misalignment . 

Under the circumstance that a country on the priority action list did not take action within 360 days the U.S. Treasury would request consultation with the WTO. The Treasury secretary would ask the Federal Reserve to take intervening action and the Treasury department would oppose increased voting shares to any financial institution if the violating country would benefit. 

Should The U.S. Make RMB Appreciation A Top Priority?

The are some U.S. economists that acknowledge that China’s actions have distorted the exchange rate between the dollar and the RMB, but they argue that the RMB would not have a major impact on the U.S. economy. Economist Derek Scissors argues that the appreciation of the RMB would only affect a few thousand jobs. Scissors asserts that China’s subsidies and regulatory protections makes it difficult for imports from other countries to compete. “The degree of the state predominance caps the total share available to all domestic private and foreign companies” . Economist Michael Pettis argues that China’s policies have kept lending rates to Chinese firms artificially low. Pettis argues that as long as China subsidizes production growth it will be difficult to increase domestic demand. A study by the Federal Reserve Bank of San Francisco argues are small relative to the U.S. G.D.P. The Bank's study concluded that for every dollar spent on Chinese products, 55 cents goes to services provided by U.S. companies. 

China and BRICS

Currency manipulation is not the only way that China is attempting to compete with the West. According to Mishra (2014) BRICS, comprised of Brazil, Russia, India, China, and South Africa, is making moves to challenge the economic dominance of the West . The headquarters for the new development bank is in Shanghai. The BRICS bank in China is setup to be the biggest threat to the World Bank and the International Monetary Fund. BRICS countries make up 40 percent of the world population and 25 percent of the world economy. China is working hard to use BRICKS to break U.S. hegemony. Misra (2014) argues that of the BRICS countries only China is a legitimate economic rival to the U.S. Although many of the BRICS nations enjoyed economic success in the early 2000’s the economic recession of 2008 hurt the economies of the BRICS nations. The creation of BRICS is simultaneously a move to restore the economic power of the east and to dethrone the U.S. from its position of economic monopoly. Misra (2014) notes the biggest challenge for China is to generate economic growth through mobilizing economic consumption .  

China’s Central Bank and Rate Cuts

China’s attempts to establish BRICS and compete with the West have been stymied by recent economic troubles. Following China’s worst economic performance since the international recession China enacted two policies to prop up its economy in late 2015. The Chinese Central Bank cut benchmark interest rates by a quarter point and reduced banks reserve requirement ratios by a half percentage. The purpose of these moves were to reduce the cost of corporate financing and to inject liquidity into the Chinese economy. The actions by China’s Central Bank marked the 6th interest rate cut since November. Additionally, China removed caps on deposit rates. The risk of broad credit easing is that money may be directed to unproductive sectors of the economy. To avoid that problem banks will be allowed to set their rates more freely. 

Saving the Chinese Economy

In spite of the measures taken by the Chinese Central Bank over the last year the Chinese economy has struggled to return to its former strength. The extreme selloff of Chinese stocks in the summer of 2015 sparked rare policies, like the simultaneous lowering of interest rates and reserve requirements. Production for industrial companies in China fell by 8.8 percent from the previous year. Coal, oil, and metal companies were hit hardest by the declines. The latest move by the Chinese government are designed to get more capital to private companies that hire larges percentages of citizens.  

Discussion

If China were to allow the market to determine the value of the RMB it would most likely reduce the U.S. Trade deficit. However, China would stop purchasing U.S. assets and the U.S. would need to find new lenders. Some economists fear that the drop in demand for U.S. assets from China would reduce the value of the dollar and destabilize the U.S. economy. 

China could go to a floating exchange rate. A Floating exchange rate would allow private citizens to purchase and sell foreign currency without limitations. However the Chinese government fear that a large private capital outflows could lead to a banking crisis. Another policy option is for China to maintain the status quo. If China were to maintain the status quo the real rate would be determined over time by inflation. This policy would probably lead to a decline in the trade deficit. However, neither of this policy option guarantee a creation of balance between the U.S. and Chinese economy. 

The two major options for creating balance appear to be a market based solution and a fixed exchange rate. However, a swift transition to a market based exchange rate could cause more harm than good. Accusations that China has manipulated the RMB are most likely accurate. However, accusations that China’s policies have cost the U.S. a significant amount of jobs are probably exaggerated. Additionally, the low evaluation of the RMB benefits U.S. consumers and U.S. firms that buy Chinese parts. 

While in political and economic competition, China and the United States have economies that are currently dependent on each other for success. China’s currency policy and interest rate cuts are only temporary solutions. The only way to fix China’s economy is by stimulating consumption among the Chinese population. The Chinese government must build the infrastructure and provide programs and training that will help private businesses. Only after China fixes its domestic economy can it expect to successfully compete with the IMF and the World Bank through BRICS.

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