January 23, 2009
In a written statement submitted to the Senate Finance Committee on January 22, 2009, Timothy Geithner, the Obama Administration’s nominee for Treasury Secretary, said that China was “manipulating” its currency. This suggests that the new Administration may be willing to take tougher steps against China’s illegal efforts to artificially cheapen its imports, thereby subsidizing and stimulating exports to the United States and other countries.1 This statement represents an important shift in attitude from the Bush Administration and former Treasury Secretary Paulson, who followed a policy of accommodation with China on currency issues through a series of “Strategic Economic Dialogues”. Although the yuan did gain about 20% in value between July 2005 and June 2008, the best estimates are that it needs to rise at least 30% more in value (Cline and Williamson, 2008).
China has violated all established currency manipulation standards, as Josh Bivens and I previously demonstrated. The most direct and important measure of currency manipulation is China’s massive accumulation of foreign exchange reserves. In the past four years alone they have purchased $1.3 trillion dollars in foreign exchange, and about 70% of its reserves are held in U.S. treasuries and other dollar-denominated assets. China’s total reserves reached almost $2 trillion by the end of 2008, as shown in the Figure below. Between April 2007 and April 2008, China acquired more than $500 billion in reserves in that single year, alone.
China’s currency manipulation and cheap currency has resulted in soaring exports to the United States which have decimated U.S. manufacturing. Between 2001 and 2007, the growth of the U.S. trade deficit with China eliminated 2.3 million jobs in the U.S., and more than two-thirds of those jobs lost were in manufacturing. China is responsible for a growing share of the U.S. trade deficit. In 2008 China’s share of the trade deficit in non-petroleum products reached 75%.
It remains to be seen whether Secretary Geithner will use all the tools at his disposal to get tough with China about currency issues. In our Trade policy recommendations to the Obama transition team we recommended that The Treasury should immediately review and update the most recent “Report to Congress on International Economic and Exchange Rate Policies.” There is ample evidence that China maintains large and persistent current account surpluses and engages in massive foreign exchange intervention in order to maintain a weak real exchange rate. China meets the standards set out in section 3004 of the Omnibus Trade and Competitiveness Act of 1988 of currency manipulation, and should be identified as a currency manipulator by the Secretary. However, the Bush administration repeatedly discounted all available evidence in these reports and consistently concluded that “Treasury has not found that any major trading partner of the United States met the standards identified in Section 3004 of the Act during [any] reporting period.” The true test of Geithner’s willingness to get tough with China is whether he will be willing to identify China as a currency manipulator in the next International exchange rate report. This action will require the administration to enter into negotiations with the Chinese, and to work with the IMF to confront China about the destabilizing impacts of its currency manipulation.
Lastly, it is important to address concerns that China could sell off some of its vast hoard of treasury securities if it is displeased by administration actions on the currency issue. This is a false threat. China is averse to any form of economic instability, especially in currency markets. The mere threat that China might sell off some Treasuries could cause a run on the yuan by private investors, resulting in its rapid and unavoidable appreciation. This is precisely the thing China most wants to avoid.
The Obama administration needs to work with China to ensure that is completes its own economic stimulus plan, and follows up with additional stimulus as needed, while it raises the value of the yuan and weans itself from excessive reliance on export led growth. The U.S. can no longer afford to be the consumer of last resort for all of China’s surplus manufactured products, nor the employer of last resort for its workers.
Cline, William R. and John Williamson. 2008. “New Estimates of Fundamental Equilibrium Exchange Rates.” Washington, D.C.: Peterson Institute. PB 08-7.
1. The Chinese currency is called the Renminbi, and the unit of account is the yuan, unlike most other currencies which use the same name for both purposes. The Chinese yuan was “pegged” or fixed against the U.S. dollar for many years. China began a tightly controlled “float” of the yuan in July 2005. It gained about 20% in value between 2005 and June 2008, but its value has stabilized since that time. Since the yuan is pegged to the dollar, it loses value relative to other currencies when the dollar falls, as it did between February 2002 and July of 2008.