In light of this afternoon’s cloture vote in the Senate on China’s currency bill, I think it would be helpful to go over why the bill is so important. Simply put, unlike most bills that proponents claim are about “job creation,” this one actually is. Since it entered the World Trade Organization in 2001, China has engaged in massive intervention in currency markets, buying U.S. dollar-denominated assets to boost the value of the dollar and keep their own currency artificially cheap. This acts as a subsidy to U.S. imports from China, and it raises the cost of U.S. exports — both to China and to every country where U.S. exports compete with goods coming from there.

Between 2007 and 2010, China invested nearly $450 billion per year in Treasury bills and other foreign exchange reserves to keep its own currency cheap. In the year ending June 30, 2011, China’s purchases of foreign exchange surged to nearly $730 billion, and its total holdings reached $3.2 trillion, as shown in the figure below. Roughly $2.2 trillion (70 percent) of China’s foreign exchange reserves are held in Treasury Securities and other dollar denominated assets.

Click figure to enlarge

The best estimates arethat the Chinese currency, known as the yuan (also known as the Renminbi, or RMB), is undervalued by approximately 28.5 percent, relative to the dollar.  China’s currency manipulation has compelled others to follow similar policies in order to protect their relative competitiveness and to promote their own exports. Hong Kong, Malaysia, Taiwan, and Singapore have currencies that are undervalued by 27.5 percent to 38.5 percent against the dollar.

In The Benefits of Currency Revaluation I showed that full revaluation of the yuan and other undervalued Asian currencies would improve the U.S. current account balance by up to $190.5 billion, increasing U.S. GDP by as much as $285.7 billion, adding up to 2.25 million U.S. jobs over the next 18-to-24 months, and reducing the federal budget deficit by up to $857 billion over 10 years. This change to the current account balance would also help workers in China and other Asian countries by reducing inflationary overheating and increasing workers’ purchasing power.  Revaluation is a “win-win” for the global economy.