China Fixes Value of Yuan
January 1994. China has maintained a fixed exchange rate for the yuan
relative to the U.S. dollar since 1994. This has recently attracted
attention as some have voiced concern that holding down the value of the yuan is making
the prices of Chinese exports to the U.S. too cheap.
A press release from the U.S. Treasury set forth the case against China's
fixed exchange rate policy:
October 1, 2003
JS-774
"China’s Exchange Rate Regime and its Effects on the U.S. Economy"
John B. Taylor Under Secretary of Treasury for International Affairs
Testimony
before the Subcommittee on Domestic and International Monetary Policy,
Trade, and Technology House Committee on Financial Services
October 1, 2003
Chairman King, Ranking
Member Maloney, Members of the Subcommittee, thank you for giving me the
opportunity to testify on
China’s exchange rate regime and
its effects on the
U.S. economy.
This is the fifth time that
I have appeared before this Subcommittee as an Administration witness. Each
time I have been asked to focus on an important facet of our international
economic policy. I have testified on our policy toward emerging markets, on
our policy for developing countries-including reforms at the Multilateral
Development Banks and the new Millennium Challenge Account, and on our
policy to remove barriers to the free flow of capital in our trade
agreements-including those with
Singapore and
Chile. In each of these cases,
an underlying goal of our policy has been to raise economic growth and
increase economic stability around the world, and in doing so benefit the
American people with more jobs, more security, and a better life. My
testimony today on
China’s exchange rate regime
will be no different in this respect.
The Overall International
Economic Strategy for Growth and Stability
The Administration’s major
economic endeavor now is to strengthen the economic recovery in the
United States. The President’s
Jobs and Growth package, enacted into law this summer, was essential, as are
his proposals for tort reform, regulatory reform, and health care reform.
But there are barriers to economic growth and stability in other countries-
in
Europe, in
Asia, in
Latin America, in
Africa-as well as in the international trade and
financial systems that have important implications for growth in the
United States.
This is where our overall
international economic strategy fits in. Our policy toward
China-and
China’s exchange rate regime in
particular-is part of that overall strategy. The strategy has been to urge
the removal of rigidities and barriers wherever they exist, and to encourage
pro-growth, pro-stability policies that benefit the
U.S. and the whole world. It is
a two-track approach-domestic and international. The international
component is applied bilaterally and multilaterally.
Progress on Growth and
Stability
I am pleased to report that
this endeavor is working. Thanks to the fiscal and monetary policy
responses, economic growth in the
United States is picking up
significantly now after the severe shocks of the terrorist attacks, the
corporate accounting scandals, and the stock market drop of 2000. Global
growth is also improving. There is more evidence of stronger economic
growth in the world’s second largest economy,
Japan, and in
Canada and the
United Kingdom, as well as
several emerging market countries.
There is also a notable
improvement in economic stability around the world, despite the
uncertainties about terrorist attacks and the ongoing war against terror.
The number and severity of financial market crises are down, capital flows
are up, and interest rate spreads are down compared with the late 1990s.
This improvement in global economic stability is important for the
United States. Greater economic
stability is essential to creating a long lasting recovery, which is needed
for sustainable job creation.
Agenda for Growth
Despite this progress on
the growth and stability front, we need to do more. During the summer
months, Secretary Snow embarked on an international pro-growth tour starting
in Europe, continuing on to Asia (including China as I will shortly discuss
in more detail), and culminating in the annual meetings of the World Bank
and the IMF in the Middle East where he forged an agreement on a new “G7
Agenda for Growth.” This milestone agreement creates for the first time
supply side surveillance - a process of benchmarking and reporting in which
each G7 country takes actions to spur growth and create jobs. It focuses on
supply-side policies that increase flexibility and remove structural
barriers to growth, because such policies are most needed to raise growth
among our G7 partners, especially those in the European Monetary Union.
For its part the
United States will work to lower
health care costs, reduce frivolous lawsuits, and streamline regulations and
needless paperwork. The other G7 countries are endeavoring to implement
other supply side policies. For example,
Germany is focusing on labor,
health, and pension reforms.
Our engagement to foster
pro-growth, pro-stability policies extends to the emerging markets and
developing countries. For example, we recently created a new United
States-Brazil “Group for Growth” through which the two countries will work
together to identify pro-growth strategies at the micro as well as macro
levels. And the Millennium Challenge Account is aimed at encouraging
pro-growth policies in the developing countries. Our reforms also call on
the World Bank to encourage economic growth by using IDA funds for the
private sector as, for example, in the new IDA/IFC small business loan
program for
Africa. And we will continue to promote trade
through the bilateral, regional, and global trade agreements. While the
outcome at
Cancun was a missed opportunity for global trade
liberalization, our free trade initiatives, including the
U.S. proposal to cut tariffs to
zero in manufacturers will continue.
Policy Principles Regarding
Alternative Exchange Rate Regimes
Exchange rate policy also
has bearing on growth and stability. The move by several large emerging
market countries-such as
Brazil,
Korea, and
Mexico-to flexible exchange
rates combined with clear price stability goals and a system for adjusting
the policy instruments is one of the reasons we are seeing fewer crises and
greater stability.
We emphasize that the
choice of an exchange rate regime is one where country ownership is
particularly important. We also recognize that, especially in the case of
small open economies, there are benefits from a “hard” exchange rate peg,
whether dollarizing, as with
El Salvador, joining a currency
union, as with
Greece, or using a credible
currency board, as in
Bulgaria or
Hong Kong.
The Economy of
China
With this context, let me
now address
China’s economy and its exchange
rate regime. Economic reforms in
China have increased economic
growth and have made
China one of the largest
economies in the world.
China is now a major economy,
and it is still growing rapidly. It is already an engine of global growth.
With per capita income of only about $1,000 per year and with financial,
legal and regulatory systems in need of reform,
China still faces challenges in
its effort to catch up with developed economies.
China’s Exchange Rate Regime
For nearly ten years now,
the Chinese have maintained a fixed exchange rate for their currency, the
yuan, relative to the dollar. The rate has been pegged at about 8.28 yuan/dollar
for the entire period. Thus, as the dollar has appreciated or depreciated
in value relative to other currencies, such as the Euro, the yuan has
appreciated or depreciated by the same amount relative to these other
countries.
To maintain this fixed
exchange rate, the central bank of
China has had to intervene in
the foreign exchange market. It sells yuan in exchange for dollar
denominated assets when the demand for the yuan increases and it buys yuan
with dollar denominated assets when the demand for the yuan decreases.
Recently the central bank has intervened very heavily in the markets to
prevent the yuan from appreciating. Since the end of 2001, dollar buying
has been so great that the foreign reserves held by the Chinese government
have risen by $153 billion to over $360 billion.
This accumulation of
foreign exchange reserves would tend to expand
China’s money supply, although
in recent months the Chinese central bank has moved to reign in monetary
expansion. Among other measures to sterilize reserve accumulation, the
central bank has - for the first time - begun issuing central bank paper to
restrict growth of the monetary base. Nevertheless, the broader money
supply continues to grow very rapidly: M2 climbed 22 percent over the 12
months ending in August 2003.
It is also important to
recognize that
China still has significant
capital controls.
China’s capital controls allow
for more inflows than outflows, thus bolstering foreign exchange reserves.
China is gradually loosening some controls (on securities rather than debt),
and outflows are likely to grow as new channels develop for Chinese to seek
diversification and better returns than those offered by low domestic
interest rates. Indeed, there is already significant leakage of capital. A
relaxation of controls on outflows would reduce upward pressure on the yuan.
Impact on the
United States
U.S. imports from
China are equal to about 1
percent of U.S. GDP, or 11 percent of total
U.S. imports. Although this
share may seem small,
China’s imports to the
U.S. have been increasing rather
rapidly, between 20 and 25 percent in recent years and months. In general,
these imports result from
China using low-skilled labor to
assemble and process imported parts and materials originating in other
countries-mostly from other Asian countries that have traditionally exported
directly to the
U.S. Consequently, the share of
U.S. imports from these other
countries has declined just as
China’s share has increased.
Asia’s share of
U.S. imports has declined
slightly. Much of the increase in
U.S. imports from
China has come at the expense of
imports that once came directly from other Asian countries.
At the same time, growth of
U.S. merchandise exports to
China has been accelerating
recently and grew 22 percent in the first 7 months of this year. Growth has
been especially rapid in recent years for
U.S. exports to
China of transportation
equipment (including aircraft engines), machinery, steel-making materials,
chemicals, and semiconductors.
China has a large trade surplus
with the
United States. However, because
China has a large deficit with
the rest of the world, it does not have a large overall current account
surplus.
China’s bilateral trade surplus
was $103 billion in 2002 with the
U.S. while
China’s deficit with the rest of
the world was about $73 billion. Thus,
China’s current account surplus
was under 3 percent of GDP in 2002 and likely to decline to less than 2
percent in 2003. Many imports from
China are goods from other Asian
economies that are processed or finished off in
China before shipping to the
United States. Other East Asian
economies increasingly send goods to
China for final processing
before they are shipped to the
United States.
China accounted for 11 percent
of
U.S. imports in 2002, up from 3
percent in 1990. Meanwhile, the combined share of
Japan,
Korea and
Taiwan declined to 17 percent
from 27 percent over the same period.
The overall trade deficit
of the
United States is spread across
many countries of the world in addition to
China. For instance, the
overall trade deficit reached $468 billion last year with 1) the
Americas accounting for $105
billion, 2)
Western Europe $89 billion, 3) Japan $70 billion, and
4)
China $103 billion. The
U.S. overall trade and current
account deficit is due to the excess of investment over saving in the
United States. If this gap were
reduced through an increment in savings, the overall deficit could shrink as
would the size of the bilateral deficits.
What impact would a change
in the value of the yuan relative to the dollar have on the
United States economy? An
appreciation would make
U.S. exports to
China less expensive and it
would make
U.S. imports from
China more expensive. The price
of Chinese goods in the United States would not change by as much as the
change in the exchange rate, because only a portion of most exports from
China are produced in China, and because the retail price in the United
States includes marketing, transport, and other logistical costs. And with
a higher yuan, substitutes for Chinese products would likely come from
countries other than
China.
The
United States Policy Position
With its rapid growth and
substantial foreign exchange reserves,
China is now in a position to
show leadership on the important global issue of exchange rate flexibility.
China represents one of the
largest economies in the world, and a flexible exchange rate regime would be
a good policy for
China. It would allow
China to open the nation to
capital flows and reduce macroeconomic imbalances.
We have also been urging
the Chinese to build on their strong record of economic reform by moving
forward in two other areas: reductions in barriers to trade and capital
flows. In the area of trade, it is important for
China to fully implement, and
even surpass, the commitments it made to the World Trade Organization.
Tariffs on manufactured goods are scheduled to come down from an average of
about 17 percent to an average of about 9 percent. This will still be well
above the average of the
United States and other large
economies, which stand at about 4 percent. It is important that
China continue to reduce its
tariff barriers. It should also open its markets to agricultural products
such as soybeans, as well as effectively enforcing intellectual property
laws.
China’s restrictions on capital
flows are one of the major rigidities interfering with market forces. The
authorities understand this and are beginning to reduce barriers to capital
flows and develop more open and sophisticated capital markets. In fact,
China has taken a number of
steps in this area recently, including developing measures that will allow
for some cross-border portfolio investment. At the same time, the Chinese
authorities are working to strengthen the banking system and liberalize
capital flows in order to prepare for a more flexible exchange rate.
Secretary Snow encouraged
each of these steps in his trip to
Beijing last month. He met Premier Wen,
Vice Premier Huang, Central Bank Governor Zhou and Finance Minister Jin. In
all his meetings discussions were detailed and candid. He also stated
publicly, “the establishment of flexible exchange rates, of a flexible
exchange rate regime, would benefit both our nations as well as our regional
and global trading partners.” The Chinese reported that they intend to move
to a market-based flexible exchange rate as they open the capital account.
Secretary Snow’s visit to
Beijing was associated with announcements
by
China’s central bank, including
liberalized regulations for foreign firms managing their foreign exchange
and significantly liberalized provisions to allow Chinese travelers to take
foreign currency out of the country and to do so more frequently. We will
continue to urge the Chinese to make rapid progress in these areas.
We are working on a
possible technical cooperation agreement in the financial area. We intend
to continue the high level conversations on this subject begun by Secretary
Snow.
In addition, following
Secretary Snow’s visit, the Chinese and the G7 agreed to engage in talks
about economic issues. This represents another example of how
China, the
U.S. and other affected parties
can come together to work on an issue of vital interest to them all. The
first meeting between senior officials from the G-7 and
China’s finance ministry and
central bank took place last week in
Dubai, where the Chinese economy, the G7
economies, and other economic issues, were discussed. Further meetings will
be scheduled on a regular basis with
China, the
United States and the other G7
countries. After the
Dubai meeting,
China’s central bank
representative said that
China is moving as fast as it
can in its reform.
Conclusion
I am pleased to report that
our efforts to engage in financial diplomacy are bearing fruit. Active
engagement with
China and other countries is
paving the way toward freer markets. The Administration’s effort to raise
growth in the
United States and abroad, and
thereby create jobs at home is already showing signs of success.
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