Chinese Currency Manipulation Chinese Currency Yuan CNY Renmin

Chinese Currency Manipulation?

Chinese Currency Yuan (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

Agenda n Brief History n How Currency Manipulation works n The Impacts of Manipulation n The Claims against China n Virtual Subsidy n Counter Arguments

International Currency System History n Collapse of Bretton Woods, 1971 -73 n IMF 1977 Decision n Plaza Accords 1985, G 5 devalue USD n 1997, Currency Speculation in Asian Financial Crisis n Euro intro’ 1999, G 7 intervention 2000 n IMF 2007 Decision

IMF 2007 Agreement “A. A member shall avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members. ”

China’s Currency System History n Republican China (Pre-PRC), currency problems, rampant hyperinflation n 1949 -78, Closed Economy n 1979 -1994 FEC, dual prices, Foreign Rates n 1994 began peg at 8. 28元: 1 US$ n 2005 ‘floated’ peg

July 21, 2005 “floated” the Yuan n Not really. n Government controlled rate n Max O. 3% daily fluctuation* n = Managed Float / “Dirty Float” n Market determines direction, management retards pace and prevents sudden instability. May 15, 2007 updated to 0. 5%/day.

How Manipulation* works n Prints new Chinese Yuan to make purchases of US$ assets n Chinese Government buys U. S. $ denominated assets n Excess demand for RMB is eliminated n Lowered demand = lowered value n End result: value of RMB suppressed from “naturally” occurring market price. * Distinction between management and manipulation is disputed.

Impact of Currency Manipulation (on U. S. ) Increase U. S. trade deficit n Negatively affect U. S. businesses n – Chinese imports relatively cheaper – U. S. exports to China relatively more expensive Downward pressure on U. S. interest rates (caused by increased investment in U. S. assets) n Capital inflows n Chinese purchased U. S. Treasury bills fund government deficit spending n Compositional shift in U. S. economy n Distortion to “Free Market Conditions”

Impact of Currency Manipulation (on China) n n n ‘Virtual subsidy’ Reduced risk for investors ($ peg) Increased competitiveness for FDI Higher cost foreign consumer imports Higher cost of imported factor inputs (machinery, raw materials, component parts) Lower local wages, Higher employment n Expanded Yuan supply, easy credit, nonperforming loans. n Impedes efficient allocation of resources

Who Benefits? Foreign/US firms exporting from China (400 of Fortune 500) n US consumer (cheaper goods, higher purchasing power) n Component importers from China (resources, machinery, capital inputs, etc. ) n Chinese Economy (manufacturing base, economic growth) n

Who Loses? US firms who compete with Chinese imports (US dom. manufacturing) n US Exporters trying to get into Chinese market n Chinese consumer, individual (wages depressed, low competition) n *** US firms doing business solely in Asia – profits reported in US$; Kodak/Dell case n

Impact “Production Platform China” n China runs trade deficit with all other nations (minus US, China has total deficit of 55 Bil in ‘ 06) n Foreign firms own 50% of export manufacture companies in China n Capital gains from Chinese exports therefore go to foreign (U. S. ) firms n U. S. firms lobby to protect this investment

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

What 40% undervalued means n At current ‘Managed’ Exchange Rate – 1 USD = 7. 54424 RMB – 1 RMB buys 0. 132552 USD n If actual value 40% higher? – RMB would buy 40% more – 1 RMB = 0. 185572 USD – 1 USD = 5. 38874 RMB

Counter arguments Can only impact temporary slowing of market effects (=<30 days) n Guessing actual value “tricky Business” n Manipulation only slows effect, long run the “invisible hand” balances out. n

Movement This Year

Virtual Subsidy – Case Study (US Automakers Claim) 2007 Toyota FJ Cruiser v. 2007 Jeep (Chrysler) Wrangler JKU

Virtual Subsidy – Case Study n April 2007, Automotive Trade Policy Council (Daimler Chrysler, Ford, GM) calls on G 7 Finance Ministers to address imbalance in Yen Exchange Rates n Claim n How does this work? – should be trading at 100¥: 1 USD – U. S. automakers in effect face a $4, 000 subsidy on Japanese made cars

Toyota FJ Cruiser n US market MSRP $22, 545. 00 n Manufactured entirely in Hamura, Tokyo, Japan. n All factors of production in Japan so MSRP is based on production inputs in ¥ n So that MSRP is actually ¥ 2, 682, 855 divided by April 2007 exchange rate of ¥ 119: 1 US$ to get the MSRP of $22, 545 in the U. S. market.

Jeep Wrangler JKU n US market MSRP $21, 190. 00 n Manufactured entirely in Toledo Ohio, USA. n All factors of production in USA so MSRP is based on production inputs in US$ n So that MSRP is actually $21, 190. 00 MSRP for the US market is completely unaffected by foreign exchange rates with any currency.

Virtual Subsidy? MSRP ¥ 2, 682, 855 $26, 828. 55 in US$ At ¥ 100: 1 US$ MSRP $21, 190. 00

Virtual Subsidy? MSRP ¥ 2, 682, 855 $26, 828. 55 in US$ At ¥ 100: 1 US$ MSRP $21, 190. 00 At ¥ 119: 1 US$ MSRP ¥ 2, 682, 855 $22, 545. 00 in US$ $4, 283. 55 in US$ MSRP $21, 190. 00

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

Thomas the Tank Engine (Lead-based paint optional) n MSRP $9. 89 ea. n Manufactured entirely in China, therefore MSRP based on factors of input in RMB n Current n So Exchange rate 1 US$: 7. 54 RMB actual MSRP = 74. 61 RMB expressed in US$ is $9. 89 ea.

Thomas the Tank Engine n If overvalued at 40% (“The Big if”) n Exchange n The rate would be: 1 US$: 5. 39 RMB same MSRP = 74. 61 RMB expressed in US$ would be: $13. 84 ea.

So What? n Your cost goes up from $9. 89 to $13. 84 ea. n You pay 39% increase? OR, according to US manufacturing lobby n. A US firm can make Thomas locally for less than $13. 84 ea. n Thus manufacturing and the related jobs return to the U. S.

Loss of Manufacturing to China? n Are we losing manufacturing jobs to China? n Has currency manipulation caused, or exacerbated that loss?

A drop in US Manufacturing Employment?

Long Term Trends in Manufacturing

Due to Competition, or Productivity?

Chinese Argument n n n Our developing economy is unstable Currency management necessary to prevent crisis that would impact world economy Must wait until further market reforms (SOE conversions, etc. ) are complete Chinese banking system underdeveloped Vulnerable to currency speculation (Thai Baht 1997) Political risk: currency up? > income down > employment down > worker unrest > domestic political challenge/crisis = Internal Affairs

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

U. S. Policy Implications n Legislative Action – Require reporting – Require negotiations – Institute tariffs to counter ‘virtual subsidies’ § H. R. 1002 (Spratt), S. 1586: 27. 5% tariff on Chinese goods – Prohibit US Do. D purchases from China – Ban federal procurement from the country n n n Report to IMF Clarify definitions, remove intent, Manipulation vs. misaligned

Questions?