South Western University of Finance and Economics Current Issues of the Chinese European Economics Handout Jan Wiechers

02.12.2011
Question 1: Is RMB undervalued and the cause of trade imbalance?
Cause of Trade Imbalances Biggest Trade Partners of China in 2010 $ billion

Looking at the U.S. being Chinas biggest trade partner, the economic ties

have expanded substantially in the last years Trade is expected to further increase due to Chinas rapid economic growth From $2 billion in 1979 to $385 billion in 2010 China is second- largest U.S. trading partner and biggest source of imports At the same time relatively low U.S. exports lead to trade deficit from $10 billion in 1990 to $273 billion in 2010 U.S. Trade with China: 2000 - 2010

Pro reasons: Low cost products from China increase purchasing power of U.S. consumer China at the same time fastest growing export market for U.S. products U.S. firms reduce costs by partly or fully assembling in China and become globally competitive Chinas purchase of U.S. treasury securities kept U.S. interest rates low

Con Reasons: U.S. manufacturing firms have been exposed to often perceived unfair competition Many U.S. production facilities relocated to China Loss of thousands of U.S. manufacturing jobs Chinas holding of U.S. dept might give leverage over United States

Is RMB Undervalued Chinas transition to a free market economy is still incomplete and has a lot of distortive market policies including restricting its currency to reach market level As of August 30, 2011 the exchange rate is at 6.38 to the U.S. dollar US politics claims being a de facto subsidy to low U.S. exports that acts as a tariff on Chinese imports to the U.S. RMB to US Dollar development

Since the RMB is pegged to the U.S. Dollar(Lately to a basket of currencies

with the Dollar being the dominant currency) relatively stable while the economical- as well as the U.S. dept situation has changed, an undervaluation of 25%-35% is being discussed by experts Due to its currency policy, China is holding the biggest amount of US dept Nevertheless an undervaluation can not be precisely determined Only estimates If RMB is undervalued by 30% -> Dollar is overvalued by 30% In 2006 many countries made strong allegations against Chinas currency policy

Reasons for RMB Undervaluation

1. Chinas economy experienced about 9% annual growth in the last decade.

Based on the Balassa-Samuelson hypothesis, rapid economic growth is accompanied by real exchange rate appreciation due to differential productivity growth between tradable and non-tradable sectors 2. China has become the worlds second-largest exporter with at least $970 billion in 2006. Chinas exports have observed approximately 30% development in recent years 3. There has been a compilation of $1.2 trillion in foreign currency reserves. These build-ups are claimed to be the result of manipulation of the RMB against natural forces from the market

Chinas opposition against RMB Undervaluation 1. China is highly reliant on trade and development of their exports is essential. 2. Over 200 million rural dwellers have left their virtual farms to locate work in towns. Higher economic growth is necessary to absorbing these workers into a functional economy 3. The RMB, according to the Chinese government, isnt undervalued and Chinas economic growth has nothing to do with manipulation from the currency 4. The U.S. is running a large trade and budget deficit, which is partially attributable to capital inflows from China, and should look to the weakness in their economy before pointing fingers elsewhere. 5. China is a sovereign country having a right to choose its very own exchange rate policy 6. China despite its trade surplus also has deficits with other Asian countries Effects of RMB Appreciation

1. Trading partners, such as the U.S. and also the Euro Zone will benefit by not
losing a large number of workers to the Chinese markets, as had been the case when domestic companies relocated to China under favorable economic considerations 2. Developing Asian countries will improve in a position to contend with Chinese exports if a revaluation takes place 3. Multinational corporations wont favor such a move, as maintaining the status quo allows them to continue taking advantage of the low operating costs in China 4. China would lose in the sense that its economy may likely slow