Yu Sheng

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Versus

• Yu Sheng
• John Renzelman
• Heather Roper

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• Issue
• Manipulation of currency values by China and
  other developing countries hurts the U.S.
  economy.
• Position
• Con

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China - Background

• China has risen from a poor, stagnant country to
  a major economic power in the last 28 Years.
• Prior to 1979 China was a Soviet style state
  controlled economy.
• From 1979 2005 the government opened up a
  number of free market reforms which opened up
  trade and investment
• From 1979 2006 Real GDP grew at an average of
  9.7
• Its world ranking for total trade rose from 27th
  to 3rd
• Some analyst refer to China as the greatest
  economic success of modern times

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China US Relationship

• Chinas economic rise has led to a substantial
  growth in US-China economic relations
• Total trade has grown from 4.9B in 1980 to an
  estimated 343B in 2006
• For the US, China is
• Second largest trading partner
• Fourth largest export market
• Second largest source of imports

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China - PPP
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Undervalued?

• Jeffrey Frankel Yuan 42 undervalued
• Lardy and Goldstein 15-25 undervalued
• Gene Chang 19.2 undervalued
• Steve Hanke and Michael Connoly No
  undervaluation

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China RMB Undervaluation Estimates
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Exchange Rate Policy

• China modified its currency policy July 21, 2005
  to be a Managed Float
• China would buy as many US Assets as required to
  maintain the peg Now they try to reduce the
  daily fluctuation to 0.3. Market forces are
  determining the general direction of the Yuans
  movement.
• 2005 up 22006 up 4 as of today 6
• 7.58 Yuan/
• To relieve the inflationary pressure caused by
  buying ,
• China issues bonds for the sterilization
  process
• Important to distinguish two parts of this
  policy
• Level of the exchange rate chosen
• Fixed vs. flexible regime choice

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Pros of Current FX Policy

• Some (fixed or somewhat flexible) nominal anchor
  to dollar can be desirable as a way to control
  long-term inflation, at least until the
  institutions are available to do inflation
  targeting.
• Exporters and importers dont have to bear costs
  of hedging, which are large, given that they
  invoice in dollars and other hard currencies.
• Given that portfolio capital markets are closed,
  the big problem of a fixed rate is not present
  (attack on the currency).
• Domestic financial institutions arent exposed to
  currency risk, which would have to be regulated
  in a flexible rate economy.

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Piece of puzzle

• One step appreciation
• Tend to cause deflation if too much like Japan
• J-curve effect for US in short term
• Too slow of an appreciation
• Vulnerable to attacks by hot money
• 1.2 trillion foreign reserve which equal 18 month
  import value-- far beyond normal practice of 6-9
  month import value
• The scenario of free-float in order to limit
  fluctuation to 2

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In near future

• More flexibility may be desirable because
• China is a large economy, and may benefit from
  monetary policy autonomy and more open capital
  markets, and the trilemma dictates that you can
  only have both of those with a flexible exchange
  rate.
• Avoids currency attacks, so it encourages more
  open portfolio flows policy.

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Concerns

• While many have marveled at Chinas rise, at the
  same time it has raised a number of concerns by
  the US and other developed nations.
• Many perceive China as a threat to the US economy
• The two economies are perceived as being part of
  a zero-sum game

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Concerns

• Areas of Concern
• Unfair Economic Policies Pegged/Undervalued
  Currency
• Surge in imports viewed as threat to certain
  American sectors (Manufacturing)
• Fear of China taking over the US in the future as
  the largest economy and largest exporter
• Negative consequences of Chinese growth, such as
  increasing demand for oil and raw materials.
• China reducing its large holding of US Treasury
  securities

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Benefits

• In general, trade increases economic well- being
• Cheap imports
• Capital equipment
• Inputs for final products
• Increased purchasing power of US consumers thus
  stimulating the economy

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Benefits

• Largest Purchaser of US Securities helping to
  fund US budget deficit
• Creates greater demand for US securities
• Greater demand helps to keep lower interest rates
  in US Debt
• Reduced interest rate increases interest
  sensitive spending throughout the US Economy also
  
• There is really no risk of a large sell off of
  Chinese held securities because the impact of a
  large sell off would be as detrimental to China
  as well as to the US

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Benefits

• Strong demand for imports of high tech capital
  goods from U.S.
• High-tech components are sent to China for
  Assembly
• Cheaper cost of low level assembly labor creates
  a lower cost product when final good is imported
  back to the US.

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Benefits

• Exports to China continue to grow
• These exports are included in final assembly of
  imported components
• China is 4th largest importer of US goods
• Repatriated earnings of US companies in China
• Increased FDI in China from 109M in 1979 to 72B
  in 2005
• The Majority of FDI is in export oriented
  companies
• US FDI in China was 3.1B In 2005 and 51.1B total
  accounting for 8.2 of Chinese FDI

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Final Thoughts

• Trade is really a positive-sum activity where
  everyone can gain
• More economic loss comes from our own tariffs and
  barriers
• Long term versus short term viewpoint
• General deficit more of a concern than an
  imbalance with any one country

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Final Thoughts

• Openness of the Chinese market (as compared to
  other Asian countries at this stage)
• Concerns seem to have more political basis than
  economic
• Environmental issues and IPR violations hurt
  China as well
• More important to support and guide their change
  than to put up barriers

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• The Federal Reserves utilization of monetary
  policy has more of an impact on the US economy
  and is able to minimize possible disruptions due
  to outsourcing, trade deficits, or trade in
  general

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Federal Reserve--- reservations

• March 2005 Federal Reserve Chairman Alan
  Greenspan warned if China were to let its
  currency float immediately, as many in the US
  want, it could weaken that countrys banking
  system and threaten the world economy
• May 20, 2005 Greenspan American shoppers will
  pay higher prices but the U.S. trade deficit with
  the rest of the world won't fall if China
  revalues its Yuan currency as the Bush
  administration wants.