The U.S. Treasury Department’s most recent assessment of foreign trading partners’ exchange rate policies refused to state that China was manipulating the value of its currency to enhance its international competitiveness.1 However, a serious reading of all evidence on the matter clearly shows that China has exceeded all well-established limits that have been used to determine currency manipulation in the past.
This currency manipulation is especially problematic in light of the unprecedented size and continual growth of trade imbalances between the United States and China. The bilateral deficit with China is now responsible for roughly a quarter of the entire U.S. trade deficit, which has reached a startling 6% of gross domestic product (GDP). It is widely agreed that this deficit is unsustainable and that the process of its unwinding could be painful for both the United States and its major trading partners. The higher this deficit is allowed to go, the more wrenching this adjustment will be. China’s currency policy is a primary impediment to reducing this deficit now rather than later (when the costs will be higher).
China has violated all established currency manipulation standards
There are a number of questions that can be asked to shed light on whether or not a country is manipulating the value of its currency vis-à-vis the dollar for competitive advantage, and, whether or not this harms the United States. First, does it have a high and rising bilateral trade surplus with the United States? Second, is its global current account surplus (the broadest measure of its trade and income flows) high and rising? Third, does it possess a high and rising accumulation of international reserves?2
Table 1 below shows China’s current position in light of these questions and compares it to past cases when the U.S. Treasury Department has found that nations were manipulating the value of their currency vis-à-vis the dollar for competitive gain. On each front, the current position of China well exceeds the previous threshold that led to a finding of manipulation.
The bilateral U.S.-China surplus (as measured by the U.S. government) was $203 billion for 2005. This bilateral surplus has risen by $119 billion over the past five years and represents over 9% of China’s total GDP. In seven of the nine cases where damaging currency manipulation was found, the U.S. bilateral trade deficit was lower than 9%, and in May 1992—the first time China was found guilty of currency manipulation—its surplus with the United States was only 3.4% of China’s GDP.
China’s global current account surplus is now over 7% of its GDP, up 5 percentage points in five years. China’s reported current account surplus exceeds levels reached in four of the nine previous cases. Furthermore, there is evidence that demonstrates that China’s own trade data may substantially under-estimate its global trade and current account surpluses.3 Using data on Chinese imports and exports from its top 40 trading partners (covering 88-95% of China’s total trade), the China Currency Coalition estimated that China’s total trade surplus in 2003 was $203 billion, 341% more than China’s officially reported trade surplus of only $46 billion.
China’s international reserves increased by $207 billion in 2005, ending the year at $821 billion. The best estimates are that 70% of these are dollar reserves and that this share has remained stable over time. These international reserves constitute 36% of China’s total GDP and are sufficient to finance over a year of Chinese imports. China’s purchase of reserves in the form of dollar-denominated assets has propped up the value of the dollar, keeping the Chinese currency from gaining value. In short, these reserve purchases act as a de facto subsidy for Chinese exports into the U.S. market.
Chinese currency policies affect more than just bilateral trade between China and the United States. Since 2002, the dollar has depreciated by 36% against the euro. Since the yuan is pegged firmly to the dollar, it depreciated as well. Since 2003, Chinese exports to the EU-25 (made much more competitive by the euro/dollar depreciation) are up by over 52 billion euros, while U.S. exports to these countries are up just over 5 billion euros (see Figure A). Thus, the yuan-dollar currency peg affects third-party (China/European Union) trade relationships as well.
Similarly, there is a cost to developing nations from the Chinese currency peg. By pursuing mercantilist exchange rate policies, China has robbed market share from smaller developing countries and forced many into managing their own exchange rates with the goal of matching China’s competitive position. Many of them would prefer a more flexible currency regime but cannot allow themselves to get priced out of competitiveness in the U.S. market through China’s manipulation.
China’s exchange rate manipulation is one of the primary impediments to resolving global trade imbalances that threaten both individual and the global economies. A revaluation of the Chinese currency is a crucial part of a policy package that would pay dividends to the United States, the European Union, poorer developing country exporters, and even China itself in the medium- to long-run.
Damage to specific U.S. market sectors
The rapid growth of the (total) U.S. trade deficit since 1997 has displaced jobs in the tradable-goods sectors of the U.S. economy—primarily manufacturing jobs. The ratio of domestic production to domestic consumption in the U.S. manufactured goods market dropped from 92% in 1997 to 78.2% in 2005, a decline equivalent to $420 billion of manufacturing output, as shown in Table 2. Chinese manufacturing imports were responsible for just over 36% of this decline, as shown in Figure B.
China, traditionally an exporter of non-durable, labor-intensive goods, has recently moved into the production of durable goods as well, as shown in Table 2. The U.S. market share of imports from China of non-durable commodities such as paper, chemicals, and rubber and plastic products doubled from 2.5% to 5.0% of the U.S. market between 1997 and 2005. Imports of durable goods more than tripled (from 2.9% to 9.7%) and accounted for 46% of the drop in the total U.S. market share in durable goods during this period (Figure B).
In short, China’s export growth has been almost across-the-board. Between 1997 and 2004, China’s share of the U.S. apparel market (a traditional strength for China) rose from 16.7% to 24.7%, an increase of 7.4 percentage points. In the same period, its market share in computers/electronics and electrical equipment jumped 14.9 and 8.2 percentage points, respectively (Table 3).
All told, Scott (2005)4 found that rising U.S./China trade deficits, spurred by China’s currency policies, led to the displacement of 869,000 jobs in tradable-goods sectors between 1997 and 2003.
Every available indicator demonst
rates that China is manipulating the value of its currency with the intent of spurring the growth of its trade surpluses. This currency manipulation has had damaging effects on some sectors of the U.S. economy and has been a primary contributor to the enormous run-up in the American trade and current account deficits. For the sake of stability in the U.S. economy, the Chinese economy, and the global economy, action needs to be taken to begin unwinding these imbalances.
1. U.S. Department of Treasury. 2006. Report to Congress on International Economic and Exchange Rate Policies. May. http://www.ustreas.gov/offices/international-affairs/economic-exchange-rates/.
2. Reserve purchases (specifically dollar reserves) are the mechanism through which currencies are manipulated vis-à-vis the dollar.
4. Scott, Robert. 2005. U.S.-China Trade, 1989-2003: Impact on Jobs and Industries, Nationally and State-by-State . EPI Working Paper #270. http://epi86dev.wpengine.com/content.cfm/wp270.