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Assignment Questions

Is China Currency Too Strong?

Case 2-2

Is China Currency Too Strong?

In July 2005, the People Bank of China announced the end of 10-year effort to peg the value of the Chinese currency, the Yuan, to the value of the US dollar. Instead, the Yuan would be linked to a basket of several foreign currencies. The announcement signaled Beijing’s decision to abandon a policy of fixed exchange rates, according to which 8.28 Yuan equaled $1, and adopt a policy of flexible rates. In short, by ending the peg, china’s central bank was finally allowing the Yuan to float.

The United States and other key trading partners had been urging such an action for years. The New York times called the Chinese central bank’s decision “the most hotly anticipated event for the foreign-exchange world in years.” Many economists believed that the Yuan had been undervalued relative to the dollar and the other currencies by as much as 40 percent, and this weakness was cited as one of the factors contributing to growing trade deficits with china. For example, the US trade deficit with china was more than $200 billion in 2006. This had occurred, it was argued, because the Chinese government had deliberately manipulated its currency to give Chinese exports a price advantage compared to goods from the United States and other countries.

Some observers favored a quick change in the Yuan’s value; others argued for a go-slow, gradualist approach. The immediate result of the reevaluation was a 2.1 percent increase in the Yuan’s value, to 8.11 Yuan equals $1. The stronger Yuan was expected to have a ripple effect on the economies of china’s top trading partners. For one thing, it was likely to result in increased prices for Chinese exports to the United States and elsewhere. This would be good news to some of the 12,000 members of the national association of manufacturers (N.A.M). Many small factory owners in the United States are worried about competing with low priced Chinese goods. However, a stronger Yuan could be bad news for the wal-mart and other retailers that buy billions of dollars worth of goods from chinaeach year. Likewise, American-based global companies such as whirlpool that source manufactured goods in china might be forced to raise prices.

By mid-2007, the Yuan had appreciated about 8.5 percent against the dollar. However, that was not enough to satisfy some policymakers. Impatient with slow pace of reevaluation, some members of the US congress introduced legislation designed to punish china for its currency policy. One bill, co-sponsored by senate finance chairman Max Baucus, a democrat, and Charles Grassley, the Republican senator from Iowa, was contingent on the US Treasury department determining that a “currency misalignment” had occurred. Following such a finding, the United States would impose fines in the form of antidumping penalties and the Chinese government would have six months to make the required currency adjustments. If china didn’t take action, the US trade representative would request dispute settlement at the WTO. A final ruling would be issued in 2010.

The introduction of the Congressional bill raised several questions. For example, it was unclear whether a dispute involving currency issues was a legitimate trade issue that the WTO would agree to hear. Another issue was whether it was possible to determine exactly how much the Yuan would have to appreciate for it to be fairly aligned with the dollar.

Some observers warned that the Baucus-Grassley bill and others like it could undermine the trade relationship between the United States and China and actually harm US companies that do business with china. Since joining the WTO in 2001, china has become America’s fourth largest export market. According to a study by the American chamber of commerce in china, American companies sold $61 billion worth of goods to china in 2005. Chamber chairman James Zimmerman noted, “A revalued Yuan will not force the Chinese to buy American goods and services.” Others warned that the Chinese companies could diversify their export base by expanding trade with other countries. A trade war was another possibility. Scott Miller, director of trade policy for Procter & Gamble, said, “You can’t rule out a backlash. That ought to be part of the calculus that lawmakers should consider.” Some observers raised concerns that, in retaliation for tradesanctions, china might restrict market access for American goods.

Answer Discussion Questions 1-3, Microsoft formatted document (.doc)with in-text citations “APA style” in the body of the report.

1. Consumer goods, including shoes and electronics, represent about 80% of U.S. Imports from China. American consumers have saved an estimated $600 billion over the past 10 years by buying inexpensive Chinese goods. If the Chinese government revalues the Yuan by 20 percent or more and American consumers pay higher prices, is this a desirable outcome?

2. Protectionist sentiments in the United States are fueled by the argument that China is to blame for the flood of imports, the giant U.S. current account deficit, and downward pressure on wages in some industries. Do you agree? (Support your answers with more than agree/disagree).

3. Do you think an aggressive legislative posture with respect to China‘s currency is the best approach for any trade partner to take? (Be specific).

Sources: John McCary and Andrew Batson, “Punishing China: Will it Fly?” The wall street journal, June 23-24, 2007, p.A4;Wu Yi, “It’s Win-Win on U.S. China Trade,”
The Wall Street Journal, May 17, 2007, p.A21; Martin Wolf, “How China has Managed to keep the Renminbi Pinned Down,” Financial Times, October 11, 2006, p.13; E.S. Browning, “Yuan Move Might Stir Big Ripples,” The Wall Street Journal, July 25, 2005, pp.C1, C4; Sue Kirchhoff, “First step: China Will Stop Pegging Yuan to Dollar,” USA Today, July 22, 2005, pp. 1B, 2B; Keith Bradsher, “ A Chinese Revaluation May Not Help U.S.,” The New York Times, January 4, 2005, pp. C1, C5.

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