The overall U.S. trade deficit with China today is expected to reach to $502.5 billion, a rise of 34 percent from 2009's figure of $374.9 billion. Several scholars accuse China for this imbalance of trade because of the value of its currency, the Renminbi. This paper investigates how fluctuation of the Renminibi (RMB) could affect the U.S. trade balance with China. Oxford Economic Forecasting model and Asian Economic Report model results indicate that an appreciation of the Chinese Yuan would result in a decrease in trade deficit for the U.S. On the other hand, many scholars studied the price elasticities for both, and it resulted in a negligible effect of China's currency fluctuation on U.S. trade balance.
PROBLEM STATEMENT
Identifying the topic, the scope, and the context of the study
The exchange rate policies are those adopted by a government, where it controls its currency, in relation to foreign currencies and the foreign exchange rate market. These policies are adopted differently in different economies; therefore, it has different regimes, mainly three. The first regime is the floating exchange rate, which is the most common regime today, adopted by the U.S. dollar, the Euro, the Japanese Yen, and the British pound, is where the rate fluctuates in relation to the market. The second regime is the pegged float rate, in which the central bank controls the currency with less deviation from the target value, adopted by China. Finally, the fixed exchange rate regime, which actually ties a currency to another one, i.e. the currencies are directly convertible towards one another, as the case with the U.S dollar and the Euro.
The Renmibi, which means people's money, also denoted as Yuan, is the Chinese currency which was establish in 1949 with the foundation of the People's Republic of China. Between 1953 and 1994, the Yuan was fixed at 2.42 Yuan/1 USD. In 1994, China unified and depreciated its currency by 50% and between 1994 and 2005, it was pegged at 8.28 Yuan/1 USD and there was no appreciation of the Yuan due to the large current account it had. In July 2005, after years of pressure from the U.S, Europe, and Japan, China's Yuan appreciated to 8.27 Yuan/1 USD based on a basket of currency. So, in 2005 the Yuan appreciated 21%, until it was begged in June 2008 at 6.83 Yuan/1 USD till June 2010, where a floating exchange rate regime is applied with 0.5% margin of fluctuation. All the pressures that China has been receiving from some main export markets, have proven that China's exchange rate policies are of a high importance to those markets and its impact on them is significant at different levels from different aspects.
Therefore, since the U.S. is one of the world's largest exporters of goods, the exchange rate policies adopted in China have a considerable impact on U.S.'s economy as a whole.
The importance of the study
This study is conducted due to the increasing concerns to the fact that the Chinese exports are severely affecting the balance of trade of the US, especially with the high level of imports from China, computed as around 2% of U.S's GDP.Also, this research is basically relevant for traders of goods, exchange rate policy makers, and central banks. It will investigate on the impact of China's exchange rate regime and will allow the U.S. trading agents to take better precautions in order to hedge this impact. Moreover, this exploration is important since it provides statistical data about the U.S. current account balance, where it is imperative to study its relationship with China's exchange rate, and to see how much the role of the latter is effective in the former's trade balance.
The major previous findings on the topic
Today, China is considered as a great threat for the US. China has been growing enormously for the last 2 decades and now it's the world's greatest exporter. In fact, China's current account surplus has been rising since late 1990s until today, reaching around 5.3% of GDP in 2010, according to the IMF data in the first 2 quarters of 2010. This advantage that China has is due to several reasons including its cheap labor and its exchange rate policies, which fluctuates its currency, Yuan, against the US Dollars. Senator Schumer, along with other members of the U.S. congress, mentioned that China, by manipulating its currency, it gains unfair trade advantages over other competing exporters worldwide. In his research about China's currency in 2010, Wayne M. Morrison, supported by Park,after analyzing the current situation of the U.S. economy, strongly believes that the main reason behind the huge annual U.S. trade deficit and the rise in the unemployment due to loss of jobs in the manufacturing sector is mainly the result of the undervaluation of the Yuan for the past several years. In fact, in one of his speeches this year, President Barrack Obama pledged to make China's exchange rate policy a top priority on his agenda since its undervaluation puts many U.S. industries/firms at a competitive disadvantage. On the other hand, several quantitative studies, have worked on discovering the linkage between China's exchange rate fluctuation, including Zhou, Bown et al.,Mann and Pluck, Kenen, and their results opposed have shown opposite views for those who believe that China's exchange rate has a direct effect on U.S. trade balance.
Research Questions:
Why is China considered as a threat for the U.S. economy?
What are the different approaches to measure the U.S. deficit?
What are the major American industries that are threatened by China's imports and how big is this threat?
BACKGROUND AND SIGNIFICANCE
Exchange rate between two currencies specify how much one currency is worth in terms of the other "( O'Sullivan, Arthur; Steven M. Sheffrin (2003). He also adds "it is the value of a foreign nation's currency in terms of the home nation's currency".
As compiled by the IMF, exchange rate regime is defined as the regime the country declares to be running, in its current market and the international market, its own currency. This regime includes different policies. First, the floating CurrencyHYPERLINK "http://www.investorwords.com/1806/exchange_rate.html"exchange rate, which is determined by free marketHYPERLINK "http://www.businessdictionary.com/definition/force.html"forces, rather than being fixed by a governmentHYPERLINK "http://www.investorwords.com/2016/floating_exchange_rate.html#ixzz161gnzGLb"(www.investorwords.com). Second, the pegged exchange rate which is an which is in turn when the government (or central bank) decides to link its currency value to another currency or to some valuable commodity like gold (www.financial-dictionary.com). Also, the fixed exchange rate is where currencies' exchange rates are set at a predetermined level and do not move in response to supply and demand (www.countrystudies.us)
The Renminbi, which means people's money, also denoted as Yuan, (Jiawen Yang, 2003)1 ,is the Chinese currency which was establish in 1949 with the foundation of the People's Republic of China. Between 1953 and 1994. theyuan was fixed at 2.42 Yuan/1 USD.( Michel Henry Bouchet,2010). In 1994, China unified and depreciated its currency by 50% and between 1994 and 2005, it was pegged at 8.28 Yuan/1 USD and there was no appreciation of the Yuan due to the large current account it had. (By RONALD I. MCKINNON, , 2006; Page A14). In 2005 the Yuan appreciated 21%, until it was pegged in June 2008 at 6.83 Yuan/1 USD till June 2010, where a floating exchange rate regime is applied with 0.5% margin of fluctuation(Wayne M. Morrison,MarcLabonte , 2010) . According to a report by UCLA University study center(2009), after the Asian crisis in 1998, the Chinese government was pressured to devaluate the Yuan in order to boost its exports, but instead, in order to protect other Asian currencies from devaluation, it did not act so, showing a leadership in the region and actually a threat for the main exporting regions, including U.S.A, E.U., and Japan, that the Yuan fluctuation can, in one way or another, affect their economies.
The increase in the imports from the People's Republic of China recently, posts threats on some of the industries in the United States and on the employment rate in the manufacturing sector, the U.S. government, basically the Congress, have been focusing on adopting a protectionism policy as to the fact that China is selling its goods at a dumping cost, resulting in an unfair competition through and to the fact that China is manipulating its currency and exploiting its workers for economic gain (Lum and Nanto (2007))
During the past years, actually starting from early 1990s, the share of China if the world trade has increased in a rapid way, and especially after it joined the WTO (World Trade Organization). As a matter of fact, China became the largest exporters in the world, along with Germany and the United States followed by an increasing trade surplus reaching $34 billion in 2004(China's custom statistics), reaching an amount of around $185 billion in 2007, especially as it ballooned in 2005 (BIS). On the other side of the coin, the U.S. has been suffering from a huge trade deficit. Today, many blame the result of the trade deficit of the U.S. to China on the value of the Yuan. In fact, according to U.S. Census Bureau (2005 and 2009 respectively), the value of this deficit was around $200 billion in 2005, increasing to around $265 billion in 2009. Actually, 28% of total U.S. deficit belonged to China (Overholt et al. 2007). According to the U.S. Census Bureau (2010), Out of a $42.775 Billion Trade Deficit, China accounts for $25.915 Billion, or 60.58%.Therefore, the U.S. congress, trying its best to protect the benefit of its economy, has been putting lots of efforts to press on the Chinese government to revaluate its currency. But how would a revaluation of the Yuan, if needed, would affect the trade balance between the two?
The literature review on the impact of the exchange rate fluctuation of China's trade balance may be divided into 2 separate groups in accordance to our findings. One group supports the fact that China's depreciation (appreciation) could effect U.S. trade negatively( positively) and the other group of researchers believe that China's exchange rate fluctuation has slight or negligible effect on U.S. trade, at least in the short run.
Soofi (2007) insists that although there is uncertainty to the validity of the RMB undervaluation, those who criticize the Chinese exchange rate believe that pegging the RMB to the U.S. dollar contributes to a major factor for the imbalance of trade in the U.S. over China. On the contrary, China responds that the productivity difference between China and the U.S. is a key factor for the imbalance between the two, and that the undervaluation of the RMB has little or negligible effect on the current balance of trade between the two. Also, it is claimed that only a temporary advantage for China over the U.S. in the balance of trade could result due to the appreciation of the RMB, unless China agrees to follow a deflationary monetary policy relative to depreciating dollar to make the revaluation more effective (Higgins and Humpage (2005) and McKinnon(2007)). Moreover, it is also stated that China might suffer the consequences as Japan did in early 1990s when it appreciated its currency which let to a long deflation decade and liquidity trap (McKinnon and Schnabl, 2005) .
Ikenson argues that RMB appreciation will not reduce the U.S. trade deficit due to the fact that between July 2005 and July 2008, the Rinminbi appreciated by 21% against the dollar (Federal Reserve Board), meaning that the trade deficit that the U.S. is running is not the consequence of China's exchange rate policy. On the other hand, China has stolen foreign technology and has created unreasonable barriers to the imports of America by substantially undervaluing it currency, hence gaining unfair trade advantages (Geithner, T(2010)). Bown et al. (2005) argues that the appreciation of the Chinese currency could actually reduce the overall trade imbalance of the U.S. trade. He also argues that, fundamentally, the U.S. deficit is related to its internal saving investment imbalance. The comparative advantage that China has through its abundant low-cost supply of labor that is increasing its skills by time, is its main key for its trade gain, and not due to its manipulation of its currency (SU 2004). Zhou(2006) argues that the U.S. current account deficit will not be solved if China balances its trade. U.S. deficit reflects fundamental saving-inverstment imbalance.
Park (2005), using the Oxford Economic Forecasting model, finds that if Chinarevalued by 10 percent the Chinese trade surplus would fall by $15 billion. Supporting his study, Kamada and Takagawa (2005), employing the Asian Economy Model, report that a 10 percent appreciation of the RMB would cause the aggregate Chinese trade surplus to fall by 0.5 percent of Chinese GDP. The IMF (2005), utilizing a partial equilibrium framework, concludes that a 10 percent Renminbi appreciation would reduce the Chinese trade surplus by $10 billion.
Mann and Pluck (2005) argue that the price elasticities of U.S. imports from Chinaare wrong-signed, and a negligible insignificant elasticity value for the U.S. exports to China
Kenen (2006) argues that there is a need to study the elasticities of export and import demand for U.S. trade with China based on disaggregated prices, knowing that the Yuan is being undervalued, as to the fact that there might be huge expectations from the policy makers and economists side about the consequences of the appreciation of the Renminbi.
Lim, Spence, and Hausmann (2006) argue, reflecting a view that is widely shared, that an appreciation of the yuan would help to reduce China's trade surplus and to promote a more balanced development of the domestic economy.Blanchard and Giavazzi (2005) also argue in favour of allowing the yuan to appreciate to reduce trade surpluses.
It is very important to notice the ranking of China as being a source for U.S. imports. In 2009, China was ranked as the 3rd largest source (not country, since this ranking is based on the fact that the 1st source is all the other nations, and the 2nd source is all EU) of imports for the U.S. according to USITC DataWeb (2009). Moreover, this source mentions that computer and parts, toys, communication equipment, apparel and audio and video equipments are the main 5 imports of the U.S. from China. As for the agricultural sector, according to the U.S. Department of agriculture, the main imports by U.S. from China in 2009 were forest products, seafood, and processes foods and vegetables.
Research Design and Methods
Collection of Data
We have collected date using qualitative and quantitative techniques. We have entirely focused on searching for the most relevant articles, research papers, and lectures about the effect of China's exchange rate policies on U.S. trade. By relevant, we mean that our selection of date had to be very precise and indicative of the real situation, therefore, it was more reliable to take sources and arguments from both, China and the U.S. The most relevant documents were the long ones, where they go into depth regarding this issue.
Source of Data
For this research paper, all the sources of data were sourced from the internet. Many documents were publishes by the governments of the United States and China. We also found lots of documents and studies by the IMF, the World Bank, and the B.I.S. which shows how this topic is quite important and case sensitive.
Research Design
The main objective is to describe how the Chinese exchange rate would affect the U.S. trade balance. In order to do that, we had to go in depth with the quantitative part which includes several approaches to measure the effects on the U.S. trade balance, bearing in mind the importance of the descriptive part (qualitative) where we found different scholarly arguments about the relationship between the two, and the several procedures that need to be taken in order to solve it.
Research strategy
Our research strategy is mostly research studies, for us to have more "on the ground" comprehension rather than theoretical ones, in order to understand what is really happening and what kind of nostalgic relationship could be brought upon between the two issues.
