China’s People’s Bank: The lady doth protest too much

On Monday, the Senate agreed to move ahead with debate on the China currency bill, approving a petition to proceed on the measure by a 79-19 marginthis morning they voted to proceed to a final vote, also by a strong margin. Predictably, the People’s Bank of China responded by claiming that the yuan (or RMB) has appreciated “greatly” and is close to a balanced level. The best indicator that China is manipulating its currency is simply that it must buy hundreds of billions of dollar in U.S. assets each year to keep it from moving ever higher. That’s how we know that they haven’t done enough.

China’s purchases of Treasury bills and other types of foreign exchange reserves have accelerated in the past year, as I showed on Monday. In the past 12 months (ending June 30, 2011), they acquired nearly $730 billion in additional reserves. Between 2005 and 2010 their reserve acquisitions averaged between $400 and $450 billion, which indicates that the yuan is even more undervalued than it was a year ago. This is true despite the yuan’s real, inflation-adjusted appreciation of 7.4 percent in the past year.

William R. Cline and John Williamson of the Peterson Institute have produced some of the best estimates of China’s currency manipulation. In a series of annual reports on fundamental equilibrium exchange rates (FEERs), they have estimated that China’s currency manipulation increased from 24.2 percent in 2010 to 28.5 percent in 2011, despite the fact that China’s real exchange rate appreciated over the past year. Three factors explain why China’s estimated FEERs increased in 2011.

First, the International Monetary Fund has estimated that China’s global current account surplus (the broadest measure of its trade balance) will more than double from $305 billion in 2010 to $852 billion in 2016 (an increase of 179 percent), as shown in the graph below.  There is widespread agreement among the G-20 leaders (including China) that global trade flows must be rebalanced to help end mass unemployment around the world. These IMF predictions show that unless China sharply revalues, world trade flows will become even more distorted than they are today. Among the top five currency manipulators identified by Cline and Williamson (China, Malaysia, Hong Kong, Singapore, and Taiwan), China is responsible for the vast majority (83 percent) of the estimated global surpluses of these currency manipulators in 2016.

Click figure to enlarge

Second, the IMF predicts that China’s current account surplus will rise from 5.2 percent of GDP in 2011 to 7.2 percent in 2016. Cline and Williamson project in their latest research China’s that current account will rise even faster, to 7.8 percent of GDP in 2016. China’s rapidly growing GDP, combined with a rapidly growing trade surplus as a share of its GDP, and its stubborn addiction to currency manipulation will, if unchallenged, destabilize both the U.S. and global recoveries, as suggested by the IMF’s own forecast of global trade imbalances shown above.

The final nail in the case against the People’s Bank is its own massive and growing accumulation of foreign exchange reserves, as noted above. China has invested trillions of dollars to prevent the appreciation of their currency to a fair market value. China’s currency manipulation is a fundamental threat to the U.S. and world manufacturing system. It artificially suppresses the value of the yuan, subsidizing China’s exports to the United States and raising the cost of U.S. exports – both to China and to every country where U.S. exports compete with Chinese products. Enough is enough. It’s time to get tough with China and other currency manipulators.