China and the Depreciating U.S. Dollar

By Burdekin, Richard C. K. | Asia - Pacific Issues, January 2006 | Go to article overview

China and the Depreciating U.S. Dollar


Burdekin, Richard C. K., Asia - Pacific Issues


[P]olicymakers who blame the policies of others for causing external imbalances, while denying their own culpability, risk destabilizing financial markets in the meantime and exacerbating the problems that policymakers should be seeking to resolve.1

The U.S. trade deficit with China nearly doubled between 2001 and 2004 as U.S. imports from China exceeded exports to China by a six-to-one margin. The Bush administration, the Kerry campaign, and individual members of Congress repeatedly blamed this disparity on the Chinese currency, the renminbi, being too cheap relative to the U.S. dollar (thus making Chinese goods overly cheap by American standards). To remedy the situation, Treasury Secretary John Snow called for a Chinese exchange-rate adjustment and increasingly vehement rhetoric ensued during the 2004 election. Then, in 2005, a series of congressional initiatives culminated in a proposed 27.5 percent tariff on Chinese imports. The level of China bashing quickly recalled the Japan bashing of the 1980s in spite of the short duration of China's large bilateral surpluses and the fact that U.S. exports to China have grown nearly as quickly as Chinese imports-with U.S. exports growing by 28.5 percent in 2003 and 22.2 percent in 2004. The problem is that the disparity in the starting levels means that U.S. exports would have to grow six times faster than imports to close the bilateral trade deficit-by comparison, the import-export ratio faced against Japan in the mid-1980s was only three-to-one.'1

Given that the United States was set to account for 70 percent of the world's current account deficits in 2005, the overall imbalance surely cannot be entirely blamed on China and its currency. For one thing, the U.S. deficit still grew even though the dollar depreciated considerably over a recent three-year period, losing nearly a quarter of its value against other major world currencies. In 2004, only three major economies (Australia, New Zealand, and Portugal) had a bigger trade deficit percentage than the United States. And, in absolute terms, that $724.5 billion U.S. deficit was nearly 15 times that of runner-up Spain with $49.2 billion.'" China's trade surplus, while large, is by no means such an outlier as the U.S. deficit. Chinese inflation and money growth rates remained reasonably contained even before the modest 2 percent July 2005 revaluation of the renminbi. With just 10.4 percent of total U.S. trade attributed to China in the first half of 2005, it is unrealistic that any exchangerate adjustment could eliminate or significantly rein in the large U.S. trade deficit.

The intense political pressure on China to adopt a more flexible exchange-rate policy ignores other issues as well. The rise in Chinese textile sales to the United States, for instance, was largely offset by reduced imports from other countries after import quotas ended in December 2004.iv Discouraging Chinese imports would likely benefit foreign producers who would then assume the supplier role, not U.S. firms. More importantly, an exchange-rate adjustment could pose considerable financial risk to the United States by threatening the vast inflow of Chinese funds. Ironically, this inflow plays an essential role in the U.S. economy as it supports the trade deficit as well as the level of U.S. interest rates (as discussed later).

Dollar Depreciation and China's Fixed Exchange Rate

Even after the dollar began weakening against other world currencies in 2002 (see Figure 1), China maintained the 8.28 exchange rate between the renminbi and the dollar that was originally fixed on January 1, 1994. Pressure to adjust such a fixed rate of exchange emerges if the prices of Chinese goods do not keep pace with U.S. prices. For example, if China's prices doubled while U.S. prices remained constant, China's exports would become twice as expensive in the United States. Demand for the renminbi would fall, putting pressure on the (now unwanted) renminbi to drop in value against the U. …

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