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Currency Revaluation


In the last decade, China’s exchange-rate policy has been an obsession in Washington. Washington politicians believed that by artificially keeping the value of the yuan low all these years, the Chinese government has ensured that Chinese products have cost less on the global markets than they otherwise would. Washington has pressed for currency revaluation as a way for China to reverse its enormous trade surplus with America. Since 2005 when the Chinese government revalued the RMB (renminbi or yuan), the yuan has risen about 20% relative to the U.S. dollar. The trade surplus, however, has not markedly decreased despite revaluation. In light of this, the currency issue is no longer as salient in Washington, but some critics still believe that China’s currency should be further revalued.


History


From the founding of the People’s Republic of China in 1949 until 1994, the Chinese government tightly controlled the RMB (renminbi, meaning “people’s money” of which the yuan is the principal unit). In 1994, the yuan was pegged to U.S. dollar. Between 1994 and 2005, China was running an increasingly large global current account surplus without subsequent appreciation of the yuan. In the late 1990s, China was actually on its way to a freely floating exchange rate when the East Asian financial crisis hit in 1998, which convinced China that it had to protect its currency. Though there was pressure to devalue the yuan after the crisis in order to boost its exports, doing so would’ve led to more devaluations throughout Asia, deepening the crisis. China chose not to at that time, displaying regional leadership[1] – a fact that is often ignored or forgotten by those in America who would choose to lecture China about its global citizenship responsibilities.

In the earlier years, China was initially reluctant to revalue its currency because of a fear that a stronger yuan will hurt China’s exports, and therefore China’s growth, and that currency reform would exacerbate the uneven economic development across China’s different regions and destabilize China’s still-weak financial sector. In recent years, however, China’s rigid currency regime has limited Beijing’s options for managing its overheating economy, and has resulted in too much domestic liquidity, which has in turn caused speculation and inflationary pressures in China.[2]

In July 2005, after years of pressure from the U.S., Europe and Japan to revalue its currency, China revalued the yuan against the dollar by 2.1%, pegging the RMB to a “basket of currencies” instead of strictly to the dollar. The exchange rate at that time was around $1 = 8.27RMB. At the end of 2007, it is believed that China allowed the RMB to rise more quickly to mitigate the effects of inflation by making the RMB worth more. By July 2008, the yuan was trading at around $1=6.88RMB (a 20% rise).


U.S. Concerns


American Job Loss: It is not just the United States who has criticized China on its currency, but also the European Union and Japan, for not allowing faster appreciation. However, the U.S. has been by far the loudest and the most vocal critic because having lost around 1.3 million manufacturing jobs to China in the last ten years[3], many Americans have the belief that an artificially low yuan is the main reason that China’s manufacturing economy has an unfair competitive edge because the undervalued RMB makes Chinese products cheaper on global markets than they would otherwise be, and is effectively a kind of subsidy for Chinese manufacturers.

U.S. Trade Deficit: Critics believe that an artificially undervalued yuan makes Chinese exports cheap and American exports to China more expensive, hence contributing to the large trade imbalance between the two countries. Many Washington policymakers therefore want the Chinese government to allow the yuan to increase relative to the U.S. dollar thereby making U.S. products more competitive and thus reducing the U.S. trade deficit.


Reality Check


Since 2005 when the yuan has risen in value about 20% relative to the U.S. dollar, however, China’s currency revaluation has not brought back lost manufacturing jobs to the U.S., nor has China’s trade surplus with the U.S. diminished appreciably.

Lost Jobs
Most economists believe that while it is true that the yuan is probably still undervalued, and that low-wage workers have taken some jobs from Americans, the exchange rate is a small factor in the loss of U.S. jobs. Even if the RMB were doubled or revalued to a relatively high level, evidence has shown that the landed costs of many products manufactured in China are still below those of products that might be made in the U.S., so any kind of a currency revaluation will likely not be sufficient to move manufacturing jobs back to the United States. Instead, production will likely move to cheaper third country markets in Asia.[4]

Trade Imbalance
Despite the yuan’s 20% appreciation relative to the U.S. dollar, the U.S.-China trade imbalance has not decreased appreciably, and China’s growth has not suffered as a result of more expensive exports. A recent report by Albert Keidel of the Carnegie Endowment for International Peace argues that China’s growth all these years has in fact been driven more by domestic investment and demand than by exports, and that exchange-rate adjustments will not have any primary or long-term significance.[5] Also during this time, China’s currency has remained relatively stable because while it has appreciated relative to the U.S. dollar, it has weakened relative to the Euro, so China’s overall current account, which many in Washington have criticized as being too large, should be seen in a more global way than just through the lens of China-U.S. trade.

While a stronger yuan may adjust the U.S.-China trade imbalance at the edges by making Chinese exports a bit more expensive and making American exports more attractive (trade figures for the last few years also show that the U.S. has in fact rapidly increased its exports to China), most economists agree that simply revaluating the yuan will not solve the U.S. global trade imbalance. As long as Americans consume more than they save, there will be a trade deficit, if not with China then with another low-cost, low-wage manufacturing country. Any gains from China trade will be offset by increased imbalance with those other countries.


Looking Ahead – Careful What You Wish For


The China currency debate seems to have abated in Washington, at least for the time being. That the appreciation of the yuan has not led to a significant diminishing of the trade imbalance or brought back jobs has deprived American critics of the ability to blame China’s undervalued currency for what are more deeper-entrenched American problems.
American Exporters – should benefit as a stronger yuan should help make American exports more attractive to the Chinese, though Chinese domestic forces are just as likely to affect how much China imports from America as is the exchange rate.
American Consumers – will be hurt by higher prices of household and other goods manufactured in China as a stronger yuan is resulting in more expensive exports.
American Companies with Operations in China - A stronger yuan has also hurt American companies who have operations in China that sell back to America or to the rest of the world. American firms in China that sell to the Chinese have been less affected as they are paid in yuan.[6]

1 Charles Freeman, “Critical Questions: The China Currency Conundrum,” in Center for Strategic & International Studies Newsletter, November, 26, 2007, http://www.csis.org/index.php?option=com_csis_pubs&task=view&id=4185 (accessed 12/18/08).

2 Freeman, "China Currency Conundrum."

3 “American Jobs Displacement Dispute”, Committee 100 Issue Brief, April 2007, http://committee100.org/publications/publications_issue.htm (accessed 12/18/08).

4 Freeman, “China Currency Conundrum."

5 Albert Keidel, “China’s Economic Rise – Fact and Fiction,” Carnegie Endowment for International Peace, Policy Brief 61, July 2008, p. 11, http://www.carnegieendowment.org/publications/index.cfm?fa=view&id=20279&prog=zch (accessed 7/18/08).

6 Don Lee, “Rising currency squeezes exporters in China,” Los Angeles Times, April 9, 2008, http://articles.latimes.com/2008/apr/09/business/fi-currency9 (accessed 4/14/08).