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Rmb exchange rate and trade balance in china economics essay

Gabriel This is an early draft of an essay written for the inaugural issue of China Now successor publication to Beijing Scene, which was the widest circulation English language publication in China until the government shut it down. See China Now, Vol.

Why do top U. The basis for their argument that the renminbi RMB is undervalued is the very large trade surplus that China has with the United States and the concomitant buildup of dollar based asset reserves of China's central bank, the People's Bank of China PBOCand other financial institutions. In other words, China is using its trade imbalance with the United States to become one of the biggest creditors to the U. This mutual dependence creates unique financial risks for the United States and provides the Chinese government with a significant amount of leverage over the U.

And there's the rub.

This is why the trade imbalance is a problem. Indeed, Japan and Germany have had a similar relationship with the United States, using a trade imbalance as the basis for accumulating U. Japan's central bank still holds more U. If for some reason the Japanese central bank decided it didn't want U.

There's no reason to assume that Japanese officials would do such a thing. After all, Japan is still an ally of the United States. China, on the other hand, is not. Indeed, China is perceived in Washington, D.

This being the case, it is not difficult to understand why it might be of concern to policy makers in the United States that China is becoming such a huge creditor nation. But there are other reasons for U. Indeed, it is only because a recession is defined by output declines, rather than employment declines, that the U. It certainly does not feel like much of a recovery to most "blue collar" workers.

When was the last time an American political leader, whether elected or appointed, stood up and said, "The economy is in the dumps because I screwed up. It's my fault that millions are out of work. It is much better for one's career to divert attention to other evils that are behind the economic woes. It was not that long ago that the primary target of official scapegoating was Japan.

  • He pointed out the increasing importance of the information economy to future economic growth;
  • Why do top U;
  • Thus, it may actually benefit the Chinese economy to have such expectations raised;
  • In that sense, Chinese trade is not exceptional;
  • On the one hand, if the Chinese government dramatically expanded the trading band for RMB, such that a lot fewer yuan could be used to buy a U;
  • If the problem is insufficient demand for existing information technology, then this problem was exacerbated by the Fed's successful attempts to slow the U.

It was the Japanese who were taking good American jobs. And even more recently it was the Mexicans. But now there's a much better target. The Chinese are not playing fair. They are taking good American jobs by keeping their currency too cheap. Never mind that current economic ills can be traced to decisions made by U. It took a lot to slow down the Clinton economic boom, too much perhaps.

  1. A sharp slowdown in the Chinese economy, coupled with increased political instability, would likely cause the yuan to depreciate within the new trading range.
  2. Second, we find that Chinese multilateral trade flows respond to relative prices -- as represented by a trade weighted exchange rate -- but the relationship is not always precisely estimated. After all, Japan is still an ally of the United States.
  3. We find, first, that the Chinese currency, the renminbi RMB , is substantially below the value predicted by estimates based upon a cross-country sample, when using the 2006 vintage of the World Development Indicators. Both portfolio investors and firms engaged in direct investment in the Chinese economy would have a positive incentive to shift more resources into China while the yuan is relatively cheap, if they expect a higher dollar cost to such investments in the future.
  4. Never mind that current economic ills can be traced to decisions made by U. The basis for their argument that the renminbi RMB is undervalued is the very large trade surplus that China has with the United States and the concomitant buildup of dollar based asset reserves of China's central bank, the People's Bank of China PBOC , and other financial institutions.

The Fed raised rates far too aggressively and when the economic slowdown finally came it proved far more resistant to reversal than might have been anticipated by Fed officials who had come to believe all the rhetoric about what fantastic economic planners they were.

After repeatedly lowering interest rates and jawboning the Fed has done little more than stimulate a housing boom and growing speculative bubble in housing prices.

China's Current Account and Exchange Rate

The fact that U. But is it the negative role that these policy makers indicate it to be? The argument is that a cheap yuan results in lower unit costs for Chinese manufacturers including American and European transnationals manufacturing in Chinawhich allows for low price exports to the U. These low priced exports displace higher priced American goods, inventories buildup at U.

Thus, it is argued that Chinese officials are responsible for the job losses in the U. There are two very obvious problems with this argument.

One of the problems was made clear by Greenspan himself, although perhaps he was not aware of the contradiction. He pointed out the increasing importance of the information economy to future economic growth. To the extent the U. If the problem is insufficient demand for existing information technology, then this problem was exacerbated by the Fed's successful attempts to slow the U.

Second, and perhaps even more importantly, the Chinese government policy of buying heavily in the U.

These low interest rates have been instrumental in keeping the U. In other words, public policies formulated in Beijing have actually been beneficial to the U. Furthermore, cheap Chinese-made exports into the U. The effect of lower priced consumer goods is to increase the real income of these consumers. They can buy more, live better, than without these low cost imported goods.

The money saved on goods made in China may, in fact, result in higher purchases of the more capital and knowledge intensive goods manufactured in the United States, not to mention stimulating more spending on services and other goods that generate jobs in the domestic economy. It is, therefore, not quite so clear that an undervalued yuan if, indeed, it is undervalued is a zero sum game. Is the yuan undervalued? This is also not as straightforward as it might seem.

  1. It took a lot to slow down the Clinton economic boom, too much perhaps. But there are other reasons for U.
  2. The effect of lower priced consumer goods is to increase the real income of these consumers.
  3. The basis for their argument that the renminbi RMB is undervalued is the very large trade surplus that China has with the United States and the concomitant buildup of dollar based asset reserves of China's central bank, the People's Bank of China PBOC , and other financial institutions.
  4. The irony of all this debate about revaluing the RMB is that it has probably added impetus to American and European investors and transnationals to speedup their involvement in the Chinese economy.

Yes, China is running a trade surplus with the United States because of the demand for low priced Chinese-made goods. However, the low cost of Chinese goods is not simply a result of the value of RMB. Low unit costs are the result of relatively low dollar cost labor in China. It is quite likely that wages in China are higher, not lower, in dollar terms than would be the case with significantly less government bureaucratic intervention.

On the one hand, if the Chinese government dramatically expanded the trading band for RMB, such that a lot fewer yuan could be used to buy a U. The rise in the dollar value of the yuan might be more than compensated for by a fall in the yuan wage resulting in a lower dollar wage for Chinese workers and even lower unit costs than currently prevail.

  • The irony of all this debate about revaluing the RMB is that it has probably added impetus to American and European investors and transnationals to speedup their involvement in the Chinese economy;
  • The Fed raised rates far too aggressively and when the economic slowdown finally came it proved far more resistant to reversal than might have been anticipated by Fed officials who had come to believe all the rhetoric about what fantastic economic planners they were;
  • It was not that long ago that the primary target of official scapegoating was Japan;
  • Yes, China is running a trade surplus with the United States because of the demand for low priced Chinese-made goods;
  • It was not that long ago that the primary target of official scapegoating was Japan.

It would still be cheaper for Americans to buy Chinese goods. However, it is likely that any shift in government policy that allowed a much higher rate of unemployment and lower wages would seriously damage the domestic Chinese economy, create political instability, and halt the growth machine. A sharp slowdown in the Chinese economy, coupled with increased political instability, would likely cause the yuan to depreciate within the new trading range.

It is interesting that those who argue for a free floating yuan let the market determine the exchange rate usually argue for less Chinese government involvement in other aspects of their economy, including the labor market. A worse case scenario would be to float the RMB while simultaneously eliminating the institutional impediments to more sharply rising unemployment.

A repeat of the 1997-1998 Asian economic crisis would be, under that scenario, an optimistic outcome. At the end of the day, Chinese authorities will probably do the right thing and drag their feet on the question of revaluation, much less the issue of a free floating exchange rate. They recognize that their actions during the Asian economic crisis, keeping the peg, gained them a great deal of credibility and have been beneficial to China's economic growth and development.

This is not something that the leaders in Beijing are likely to give up easily or any time soon. The irony of all this debate about revaluing the RMB is that it has probably added impetus to American and European investors and transnationals to speedup their involvement in the Chinese economy. Both portfolio investors and firms engaged in direct investment in the Chinese economy would have a positive incentive to shift more resources into China while the yuan is relatively cheap, if they expect a higher dollar cost to such investments in the future.

Thus, it may actually benefit the Chinese economy to have such expectations raised.

At least this is the case as long as those expectations are not met.