Chinese CurrencyManipulation?

Chinese CurrencyYuan (CNY) 元Renmin Bi (RMB) 人民币Jin 金Kuan 款Tael 两Qian 钱

Yin Bi 银币Kuai 块Da Tour 大头Da Mao 大毛US$ = Mei Yuan 美元

AgendaAgenda Brief HistoryBrief History How Currency Manipulation worksHow Currency Manipulation works The Impacts of Manipulation The Impacts of Manipulation The Claims against ChinaThe Claims against China Virtual SubsidyVirtual Subsidy Counter ArgumentsCounter Arguments

International Currency System International Currency System HistoryHistory

Collapse of Bretton Woods, 1971-73Collapse of Bretton Woods, 1971-73 IMF 1977 DecisionIMF 1977 Decision Plaza Accords 1985, G5 devalue USDPlaza Accords 1985, G5 devalue USD 1997, Currency Speculation in Asian Fina1997, Currency Speculation in Asian Financial Crisisncial Crisis Euro intro’ 1999, G7 intervention 2000Euro intro’ 1999, G7 intervention 2000 IMF 2007 DecisionIMF 2007 Decision

IMF 2007 AgreementIMF 2007 Agreement

““A.A. A member shall A member shall avoid avoid manipulatingmanipulating exchange rates or the exchange rates or the international monetary system in international monetary system in order to prevent effective balance of order to prevent effective balance of payments adjustment or payments adjustment or to gain an to gain an unfair competitive advantageunfair competitive advantage over over other members.”other members.”

China’s Currency SystemChina’s Currency SystemHistoryHistory

Republican China (Pre-PRC), currency prRepublican China (Pre-PRC), currency problems, rampant hyperinflationoblems, rampant hyperinflation 1949-78, Closed Economy1949-78, Closed Economy 1979-1994 FEC, dual prices, Foreign Rate1979-1994 FEC, dual prices, Foreign Ratess 1994 began peg at 8.281994 began peg at 8.28 元元 :1US$:1US$ 2005 ‘floated’ peg2005 ‘floated’ peg

July 21, 2005 “floated” the July 21, 2005 “floated” the YuanYuan

Not really.Not really. Government controlled rateGovernment controlled rate Max O.3% daily fluctuation*Max O.3% daily fluctuation* = Managed Float / “Dirty Float”= Managed Float / “Dirty Float” Market determines direction, Market determines direction,

management retards pace and management retards pace and prevents sudden instability.prevents sudden instability.

May 15, 2007 updated to 0.5%/day.

How Manipulation* worksHow Manipulation* works Prints new Chinese Yuan to make Prints new Chinese Yuan to make

purchases of US$ assetspurchases of US$ assets Chinese Government buys U.S.$ Chinese Government buys U.S.$

denominated assetsdenominated assets Excess demand for RMB is eliminatedExcess demand for RMB is eliminated Lowered demand = lowered valueLowered demand = lowered value End result: value of RMB suppressed End result: value of RMB suppressed

from “naturally” occurring market price.from “naturally” occurring market price.

* Distinction between management and manipulation is disputed.

Impact of Currency Impact of Currency ManipulationManipulation

(on U.S.)(on U.S.) Increase U.S. trade deficitIncrease U.S. trade deficit Negatively affect U.S. businessesNegatively affect U.S. businesses

– Chinese imports relatively cheaperChinese imports relatively cheaper– U.S. exports to China relatively more expensiveU.S. exports to China relatively more expensive

Downward pressure on U.S. interest rates Downward pressure on U.S. interest rates (caused by increased investment in U.S. (caused by increased investment in U.S. assets)assets)

Capital inflowsCapital inflows Chinese purchased U.S. Treasury bills fund Chinese purchased U.S. Treasury bills fund

government deficit spendinggovernment deficit spending Compositional shift in U.S. economyCompositional shift in U.S. economy

Distortion to “Free Market Conditions”Distortion to “Free Market Conditions”

Impact of Currency Impact of Currency ManipulationManipulation

(on China)(on China) ‘‘Virtual subsidy’Virtual subsidy’ Reduced risk for investors ($ peg)Reduced risk for investors ($ peg) Increased competitiveness for FDIIncreased competitiveness for FDI Higher cost foreign consumer importsHigher cost foreign consumer imports Higher cost of imported factor inputs Higher cost of imported factor inputs

(machinery, raw materials, component parts)(machinery, raw materials, component parts) Lower local wages, Higher employmentLower local wages, Higher employment Expanded Yuan supply, easy credit, non-Expanded Yuan supply, easy credit, non-

performing loans.performing loans.

Impedes efficient allocation of resourcesImpedes efficient allocation of resources

Who Benefits?Who Benefits? Foreign/US firms exporting from China (400 Foreign/US firms exporting from China (400

of Fortune 500)of Fortune 500) US consumer US consumer

(cheaper goods, higher purchasing power)(cheaper goods, higher purchasing power) Component importers from China Component importers from China

(resources, machinery, capital inputs, etc.)(resources, machinery, capital inputs, etc.) Chinese EconomyChinese Economy

(manufacturing base, economic growth)(manufacturing base, economic growth)

Who Loses?Who Loses? US firms who compete with Chinese US firms who compete with Chinese

imports (US dom. manufacturing)imports (US dom. manufacturing) US Exporters trying to get into Chinese US Exporters trying to get into Chinese

marketmarket Chinese consumer, individualChinese consumer, individual

(wages depressed, low competition)(wages depressed, low competition) *** US firms doing business solely in *** US firms doing business solely in

Asia – profits reported in US$; Kodak/Dell Asia – profits reported in US$; Kodak/Dell casecase

ImpactImpact“Production Platform China”“Production Platform China”

China runs trade deficit with all other China runs trade deficit with all other nations (minus US, China has total nations (minus US, China has total deficit of 55Bil in ‘06)deficit of 55Bil in ‘06)

Foreign firms own 50% of export Foreign firms own 50% of export manufacture companies in China manufacture companies in China

Capital gains from Chinese exports Capital gains from Chinese exports therefore go to foreign (U.S.) firmstherefore go to foreign (U.S.) firms

U.S. firms lobby to protect this U.S. firms lobby to protect this investmentinvestment

The Claims on ChinaThe Claims on China Intentionally Suppressing RMB valueIntentionally Suppressing RMB value Fueling economic growth/boomFueling economic growth/boom Suppressing local consumersSuppressing local consumers Flooding U.S. markets – “dumpinFlooding U.S. markets – “dumping”g” Undervalued by 10%-40%Undervalued by 10%-40%

What 40% undervalued What 40% undervalued meansmeans

At current ‘Managed’ Exchange At current ‘Managed’ Exchange RateRate– 1USD = 1USD = 7.547.54424 RMB424 RMB– 1RMB buys 0.132552 USD 1RMB buys 0.132552 USD

If actual value 40% higher?If actual value 40% higher?– RMB would buy 40% moreRMB would buy 40% more– 1RMB = 0.185572 USD1RMB = 0.185572 USD– 1USD = 1USD = 5.385.38874 RMB874 RMB

Counter argumentsCounter arguments Can only impact temporary Can only impact temporary slowislowing of market effectsng of market effects (=<30 days)(=<30 days) Guessing actual value “tricky BuGuessing actual value “tricky Business”siness” Manipulation only slows effect, lManipulation only slows effect, long run the “invisible hand” baong run the “invisible hand” balances out.lances out.

Movement This YearMovement This Year

Virtual Subsidy – Case StudyVirtual Subsidy – Case Study(US Automakers Claim)(US Automakers Claim)

2007 Toyota FJ Cruiser2007 Toyota FJ Cruiserv.v.

2007 Jeep (Chrysler) Wrangler JKU2007 Jeep (Chrysler) Wrangler JKU

Virtual Subsidy – Case StudyVirtual Subsidy – Case Study April 2007, Automotive Trade Policy April 2007, Automotive Trade Policy

Council (Daimler Chrysler, Ford, GM) calls Council (Daimler Chrysler, Ford, GM) calls on G7 Finance Ministers to address on G7 Finance Ministers to address imbalance in Yen Exchange Ratesimbalance in Yen Exchange Rates

ClaimClaim– should be trading at 100should be trading at 100¥:1USD¥:1USD– U.S. automakers in effect face a $4,000 U.S. automakers in effect face a $4,000

subsidy on Japanese made carssubsidy on Japanese made cars

How does this work?How does this work?

Toyota FJ CruiserToyota FJ Cruiser US market MSRP $22,545.00 US market MSRP $22,545.00 Manufactured entirely in Hamura, Tokyo,Manufactured entirely in Hamura, Tokyo, Japan. Japan. All factors of production in Japan so MSAll factors of production in Japan so MSRP is based on production inputs in ¥RP is based on production inputs in ¥ So that MSRP is actually ¥2,682,855 So that MSRP is actually ¥2,682,855

divided by April 2007 exchange rate of ¥119:1USdivided by April 2007 exchange rate of ¥119:1US$ to get the MSRP of $22,545 in the U.S. market.$ to get the MSRP of $22,545 in the U.S. market.

Jeep Wrangler JKUJeep Wrangler JKU US market MSRP $21,190.00 US market MSRP $21,190.00 Manufactured entirely in Toledo Ohio, Manufactured entirely in Toledo Ohio,

USA. USA. All factors of production in USA so MSRP All factors of production in USA so MSRP

is based on production inputs in US$is based on production inputs in US$ So that MSRP is actually $21,190.00 So that MSRP is actually $21,190.00

MSRP for the US market is completely unaffected by MSRP for the US market is completely unaffected by foreign exchange rates with any currency.foreign exchange rates with any currency.

Virtual Subsidy?Virtual Subsidy?

At ¥100:1US$ MSRP ¥2,682,855 MSRP $21,190.00$26,828.55 in US$

Virtual Subsidy?Virtual Subsidy?

At ¥100:1US$ MSRP ¥2,682,855 MSRP $21,190.00$26,828.55 in US$

$4,283.55 in US$

At ¥119:1US$ MSRP ¥2,682,855 MSRP $21,190.00$22,545.00 in US$

Virtual Subsidy – Case Study 2Virtual Subsidy – Case Study 2(Anti-China Lobby Claim)(Anti-China Lobby Claim)

Chinese Manufacturing AdvantageChinese Manufacturing Advantage

Thomas the Tank EngineThomas the Tank Engine(Lead-based paint optional)(Lead-based paint optional)

MSRP $9.89ea.MSRP $9.89ea. Manufactured entirely in China, therefore Manufactured entirely in China, therefore

MSRP based on factors of input in RMBMSRP based on factors of input in RMB

Current Exchange rate 1US$:7.54RMBCurrent Exchange rate 1US$:7.54RMB

So actual MSRP = 74.61RMB expressed So actual MSRP = 74.61RMB expressed in US$ is $9.89ea.in US$ is $9.89ea.

Thomas the Tank EngineThomas the Tank Engine If overvalued at 40% (“The Big if”)If overvalued at 40% (“The Big if”)

Exchange rate would be: Exchange rate would be: 1US$:5.39RMB1US$:5.39RMB

The same MSRP = 74.61RMB The same MSRP = 74.61RMB expressed in US$ would be: expressed in US$ would be: $13.84ea.$13.84ea.

So What?So What?

Your cost goes up from $9.89 to $13.84ea.Your cost goes up from $9.89 to $13.84ea. You pay 39% increase?You pay 39% increase?

OR, according to US manufacturing lobbyOR, according to US manufacturing lobby

A US firm can make Thomas locally for less A US firm can make Thomas locally for less than $13.84ea.than $13.84ea.

Thus manufacturing and the related jobs Thus manufacturing and the related jobs return to the U.S.return to the U.S.

Loss of Manufacturing to Loss of Manufacturing to China?China?

Are we losing manufacturing Are we losing manufacturing jobs to China?jobs to China?

Has currency manipulation Has currency manipulation caused, or exacerbated that caused, or exacerbated that loss?loss?

A drop in US Manufacturing Employment?

Long Term Trends in Manufacturing

Due to Competition, or Productivity?

Chinese ArgumentChinese Argument Our developing economy is Our developing economy is unstableunstable Currency management Currency management necessarynecessary to prevent to prevent

crisis that would impact world economycrisis that would impact world economy Must wait until further market Must wait until further market reforms reforms (SOE (SOE

conversions, etc.) are completeconversions, etc.) are complete Chinese banking system Chinese banking system underdevelopedunderdeveloped VulnerableVulnerable to currency speculation (Thai to currency speculation (Thai

Baht 1997)Baht 1997) Political risk: currency up? > income down > Political risk: currency up? > income down >

employment down > worker unrest > employment down > worker unrest > domestic political challenge/crisis = domestic political challenge/crisis = Internal Internal AffairsAffairs

Chinese ArgumentChinese Argument Whaaaaa, Boo-hooWhaaaaa, Boo-hoo We’re a Third World NationWe’re a Third World Nation Stop Beating us upStop Beating us up American Bully!American Bully!

U.S. Policy ImplicationsU.S. Policy Implications Legislative ActionLegislative Action

– Require reportingRequire reporting– Require negotiationsRequire negotiations– Institute tariffs to counter ‘virtual subsidies’Institute tariffs to counter ‘virtual subsidies’

H.R. 1002 (Spratt), S. 1586: 27.5% tariff on Chinese goodsH.R. 1002 (Spratt), S. 1586: 27.5% tariff on Chinese goods– Prohibit US DoD purchases from ChinaProhibit US DoD purchases from China– Ban federal procurement from the countryBan federal procurement from the country

Report to IMFReport to IMF Clarify definitions, remove intent, Clarify definitions, remove intent, Manipulation vs. misalignedManipulation vs. misaligned

Questions?Questions?