Currency Manipulation and the Case for Status Quo

1
Currency Manipulation and the Case for Status Quo

• Jason Collier
• Steve Drucker
• Jay Alva
• Kevin Wesley

2
Currency Manipulation

• IMF Charter, Article 4
• Each member country agrees to avoid manipulating
  exchange rates to prevent effective balance of
  payment adjustment or to gain an unfair
  competitive advantage over other countries
• Protracted purchase of dollars could constitute
  such manipulation

3
Currency Manipulation

• Japan
• 250 Billion in foreign exchange purchases
  (almost all dollars) since 95
• 33 Billion in Sep. Oct. of 2001 when there was
  upward pressure on Yen
• Yen depreciated 15 against dollar in 2001
• South Korea
• Purchased 9 Billion in 2001 while nation had 9
  Billion trade surplus
• The Won depreciated 5 against the dollar

4
China, Manipulating?

• China in 2001
• 25 Billion trade surplus
• 45 Billion net inflow of FDI
• Purchase of 50 Billion of foreign exchange
• Foreign exchange purchase offset nearly ¾ of the
  market upward pressure on Yuan
• Based on the IMF definition, China is
  manipulating through large scale purchase of
  foreign exchange

5
Chinas Foreign Reserves
6
Yuan Undervalued?

• Claims of undervaluation based on a number of
  factors
• International price comparison
• U.S. trade deficits with China
• Chinas increasing foreign exchange reserves
• According to Economist Big Mac survey Average
  price of Big Mac in U.S was 2.71 while in China
  was 1.20
• Based on Survey, Yuan most undervalued currency

7
Yuan Undervalued?

• Based on the survey, the exchange rate of the
  Yuan to the Dollar should have been 3.65, instead
  of 8.28
• Undervalued by 56 against the dollar
• Many economists argue that the Yuan is
  undervalued against the dollar by 15 to 40
  percent

8
Yuan Undervalued?
9
Reasons to Not Revalue

• Real export dynamic comes more from outsourcing
  strategies of Western multinationals than growth
  of Chinese companies
• Nearly 2/3 of exports since 1994 is traceable to
  multinationals alone
• Revaluation of RMB would disrupt supply chain of
  new globalized production models

10
Reasons to Not Revalue

• According to Financial Times, significant
  sections of U.S. businesses are taking little
  interest in the undervalued RMB issue
• Many small enterprises suffer, while large U.S.
  companies (e.g. GM, GE, Dupont) thrive

11
Reasons to Not Revalue

• China does not compete on basis of undervalued
  currency but on other factors
• Labor costs
• Technology
• Quality control
• Infrastructure
• Improved human capital of workforce
• Passion/Commitment to reform

12
Reasons to Not Revalue

• Revaluing RMB upward 10 - exports would suffer
  minimal loss of market share
• China has reiterated commitment to opening
  capital account making currency fully
  convertible
• Premature and risky to float the Yuan until more
  financial reforms

13
Reason to Not Revalue

• Goldstein and Lardy who believe that the Yuan
  is greatly undervalued do not believe in
  floating immediately, but propose a two stage
  plan
• Stage One Medium Sized (15-20) revaluation of
  the Yuan Widening of the currency band (to
  between 5 and 6 from less than 1 switch from
  unitary peg to a basket of currencies (dollar,
  euro, and yen)
• Adoption of managed float after a strengthened
  financial system to permit liberalization of
  capital outflows

14
Reasons to Not Revalue

• Americas largest trade deficit is with China
  (103 billion dollar shortfall in 2002)
• However, for a saving-short U.S. economy, trade
  deficits are the rule not the exception
• U.S. needs surplus foreign savings (i.e. capital)
  to finance economic growth to gain this capital
  and keep balance of payments constant the U.S.
  must run current account and trade deficits
• If it these deficits were not with China they
  would have to be with other nations
• Trade deficit provides American consumers the
  cheapest of high-quality goods available

15
Balance of Payments

• BP KA CA 0
• We are not going to account for RA
• The United States is running a CA deficit so the
  US also has a KA surplus
• More capital is coming from China when US is
  running such a large CA deficit with China
• More Chinese capital in the US markets allows for
  businesses and the US stock market to grow and
  thrive

16
Buying Cheaper Goods in China

• Costs US less money to buy goods from China then
  other countries
• US citizens are able to save more money
• US citizens will have more money to spend in the
  US economy
• US will go to other countries to buy cheap goods
  if Chinas goods were more expensive
• Buying more Chinese goods allows Chinas economy
  to continue to emerge on the world economic stage

17
Revaluation of Yuan Upwards

• Negatives of Yuan Revaluation on US Economy
• Imports from China would cost more
• Firms that import Chinese components in the
  production of final goods would pay more for
  those components
• A possible decrease in capital flows from China
  could increase pressure on US interest rates
• The cost of production in dollars would increase
  and possibly raise the price of final goods
  shipped to the US

18
Impact of Chinese Currency Revaluation

• Chinese exports contain many components and raw
  materials manufactured in other countries
• Chinas value added often involves low-cost
  assembly and other labor-intensive work
• Any Increases in the price of Chinese imports,
  would probably be much less than the appreciation
  of the Yuan itself.
• - Douglas
  J. Holtz-Eakin,
• Director,
  Nonpartisan CBO

19
Computer and Electronics Industry

• The Logitech Suzhou parts warehouse
• Wanda Wireless mouse sells for 40 in U.S.
• Logitech in China earns 3 on sale
• Distributors and retailers earn 15
• Suppliers around the world earn 14
• Marketing in California earns 8

20
Computer and Electronics Industry

• Chinese share of the U.S. market rose from 4.3
  percent in 2000 to 11.1 percent in 2004
• During the same period imports overall share of
  U.S. market remained the same
• If Chinese import prices do rise other countries
  may simply fill the gap

21
The Bigger Problem -Americas Borrowing Habit

• The U.S. has been a net capital importer since at
  least the 1980s
• The example of Britain during WWI
• Commerce Department's Bureau of Economic Analysis
  show that foreign holdings of U.S. stocks, bonds
  and other assets exceeded America's foreign
  assets to the tune of 2.3 trillion -- or 22 of
  GDP --at the end of 2002 -

22
The Geo-Political Impact of China as a Lender

• China has financed U.S. government activities in
  the form of Treasury debt securities in excess of
  120 Billion
• It holds that much again in Fannie Mae and other
  dollar-denominated debt securities.
• China could one day dump its dollar assets to
  "trigger a run on the dollar, an increase in U.S.
  interest rates and perhaps a stock-market crash.
  -Aaron Friedberg of Princeton University
• Trade spurs economic, political and social
  integration

23
Greenspan on Revaluing Yuan

• Final stage of assembly becoming increasingly
  concentrated in China
• Exports reported on gross basis (not as value
  added)
• Widening of US bilateral trade deficit with China
  largely in lieu of wider deficits with other
  Asian economies (including Japan)
• Revaluation would affect Chinese value added, not
  the dollar cost of intermediate goods imported
  into China from the rest of Asia

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Greenspan on Revaluing Yuan

• Increase in exchange rate of RMB relative to the
  dollar would likely redirect trade in Asia
• Revaluation would have limited consequences for
  overall US imports
• Revaluation would also have limited consequences
  for US exports that compete with Chinese products
  in third markets

25
Greenspan on Proposed Tariffs

• Proposed broad tariff on Chinese goods would
  significantly lower US imports from China, but
  would comparably raise US imports from other
  low-cost sources of supply
• US imports from China (particularly textiles,
  light manufactures, assembled computers, toys,
  and similar products) would shift from China (as
  final assembler) to other emerging-market
  economies in Asia, and perhaps also to Latin
  America
• Significant elevation of tariffs that reduce
  overall competitively priced Chinese goods would
  materially lower US standard of living

26
Greenspan on Proposed Tariffs

• A return to protectionism threatens the
  continuation of much of the extraordinary growth
  in the standards of living worldwide
• Tariffs send the adverse message to US trading
  partners that the US accepts the benefits of
  broadened world trade, but not the costs of the
  inevitable structural adjustments
• Policy should aim to bolster the well-being of
  job losers through retraining and unemployment
  insurance

27
Greenspan for the record

• it is nonetheless the case that a more flexible
  RMB would be helpful to Chinas economic
  stability and, hence, to world and US economic
  growth.
• Testimony of Chairman Alan Greenspan
• China Committee on Finance, US Senate
• June 23, 2005

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Conclusion

• China is being accused of undervaluing the RMB
  through currency manipulation
• Significant sections of US businesses are taking
  little interest in the undervalued RMB issue
• Chinese goods are not made competitive solely
  because of the undervalued RMB
• In order to maintain adequate KA account levels
  (necessary due to low US savings), US must run CA
  account (trade) deficits.
• China is supplying low cost goods to the US
  consumer

29
Conclusion

• Revaluation would have limited effect on overall
  US imports
• In todays global economy, structural adjustments
  by each nations economy are necessary, and
  should not be avoided