Since September, the exchange rate of the Chinese yuan has again come to the fore as a key issue in China-US relations. The US government has repeatedly told China that the yuan is not being revalued fast enough, warning that it will impose further sanctions if China fails to remedy the situation. On Sept. 29 the US House of Representatives passed the Currency Reform for Fair Trade Act by an overwhelming majority of 348 votes to 79.
This pressure is making the Chinese government uneasy. Given its foreign and domestic political and economic situation, the Beijing government appears to have no choice but to adjust the yuan exchange rate to avoid a China-US trade war that would hamper its overall economic development.
The yuan exchange rate is not determined by market forces but set by the Chinese government. Since 2003, China has been buying about US$800 million each day to stop the yuan from rising against the US dollar. However, faced with economic imbalances at home and abroad as well as pressure from other countries, China had to implement currency reforms in July 2005. Between then and the outbreak of the global financial crisis in August 2008, the yuan had gained about 16 percent in value.
Once the financial storm broke out, however, the Chinese government was worried about its potential impact on the country and only allowed the yuan’s value to go up a further 0.2 percent.
China’s economy began to recover in the first quarter of last year, and since the fourth quarter of last year, it has returned to double-digit growth. The growth rate for real estate prices shot up to 12.8 percent in April this year, while inflation gradually climbed to 3.5 percent in August. Investment growth has also stayed above 20 percent throughout this year. These figures show that the Chinese economy is once again in danger of overheating.
Imbalances are all the more evident in China’s external economic relations. By June this year, China’s foreign exchange reserves had reached US$2.5 trillion, and its trade surplus hit more than US$20 billion for each of the last three months — equal to 5 percent of GDP.
As calculated by the US Peterson Institute for International Relations, for China’s trade surplus to stay at 3 percent of GDP, the yuan’s trade-weighted exchange rate must rise 15 percent, or its exchange rate against the US dollar must go up 25 percent. Beijing understands quite well that if it wants domestic demand and consumption to lead economic growth, it must adjust interest rates to slow down the inflow of foreign currency. These goals can only be achieved if the yuan’s exchange rate is made more flexible.
Although China’s internal and external economic imbalances go some way to explaining why Beijing is adjusting the yuan exchange rate, the decisive factor is probably pressure from abroad. Before China implemented exchange rate reforms in 2005, the governor of its central bank — the People’s Bank of China — said that if there was pressure for it from abroad for China to speed up its exchange rate adjustments, then it would do so. In June the Chinese government again adjusted the yuan exchange rate. The value of the yuan rose 1.9 percent by the end of September, but of this, 1.7 percent took place in September. China probably wouldn’t have adjusted its exchange rate so quickly were it not for pressure from the US Congress.
Beijing often says that the exchange rate is not the reason for China’s trade surplus and the US trade deficit. Nevertheless, a weaker dollar and a stronger yuan would indeed help to correct the trade imbalance between China and other countries. From 2002 to the beginning of 2007, the US dollar’s trade-weighted exchange rate fell by about 25 percent while that of the yuan climbed 20 percent. The effect on trade was seen after a certain time lag, as the US trade deficit fell from 6 percent of GDP in 2006 to 3 percent last year, while China’s trade surplus fell from 11 percent of GDP in 2007 to 5.5 percent last year.
However, the US trade deficit climbed from US$25 billion in May last year to US$49.8 billion in June this year. The US economy has not fully recovered and unemployment is still running high. Comparing the US economy’s sluggish performance with China’s rapid growth and thriving exports, most members of the House blame China for fixing the yuan’s rate below its real value, which they say amounts to an export subsidy. US lawmakers see this as an unfair trade practice and want to impose countervailing duties on Chinese exports. As most Asian currencies have been revalued 5 to 10 percent, a mere 2 percent rise in the yuan’s value is an obstacle to re-establishing equilibrium in international trade.
It looks as though the yuan exchange rate may go on being adjusted for the next few years, until such a time as China’s internal and external economic imbalances are gradually eliminated, its trade surplus with the US is greatly reduced, or the US economy recovers strongly.
Tung Chen-yuan is a professor in the Graduate Institute of Development Studies at National Chengchi University.
TRANSLATED BY JULIAN CLEGG
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