The RMB exchange rate and Sino-US ties
- By Ding Yifan
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E-mail China.org.cn, May 4, 2014
2. Disputes between China and the US over the yuan’s exchange rate.
After China joined the World Trade Organization at the end of 2001, foreign investment in China increased dramatically. Besides eyeing China’s market, overseas investors exported a large chunk of their China-made products to third countries. That’s why China’s exports and foreign reserves soared after the WTO entry.
China’s export consists of two parts: process trade and general trade. The former mainly stems from foreign companies’ production and exports in China. Apple’s iPhone is a typical example of process trade. It is completely manufactured in China but exported to the rest of the world. In process trade, a product’s component parts are imported to be assembled in China, and then exported to foreign markets. In international trade statistics, these products are counted as made in China and as China’s exports. But China’s manufacturers get only a small share of the profit. For example, China earns only $10 by assembling an iPhone.
Over a fairly long time period, process trade made up more than half of China’s exports. So the growth of China’s exports and foreign reserve was not necessarily part of China’s own economy, but more a result of foreign companies’ investment in China.
In 2003, Japan took the lead in blaming China, arguing that the magnificent growth of China’s exports was the result of a depreciated RMB. Then, some US congressmen also began to make an issue of the Chinese currency. They threatened to sanction China for what they called deliberate depreciation of the yuan, quoting the notorious Article 301. In the later Sino-US economic strategic dialogue, the yuan’s exchange rate was part of the discussions.
In 2005, China dumped the policy of pegging the yuan to the dollar. The yuan’s exchange rate began to float upward. According to the theory that a cheap yuan is the reason behind the strong growth of China’s exports, the appreciation of the Chinese currency would weaken Chinese products’ competitiveness, hence a decline in China’s exports. The fact, however, contradicts the theory.
After the yuan appreciated, China’s exports rose rather than fell. And China’s trade surplus soared not only with the US but also with other countries. China’s surplus with the US rose from $114.2 billion in 2005 to $170.86 billion in 2008, while total surplus in foreign trade reached a whopping $300 billion that year.
The reason was that China had restructured its economy to export more high-tech and high value-added products while lower-end industries were transferred to other Asian countries, especially Southeast Asian and South Asian countries. The US’ economy and that of China are mutually complementary. Although the yuan’s appreciation has made Chinese products more expensive, they remain indispensable in American markets. The higher the yuan’s value, the larger the trade gap between the two countries.
The 2008 financial crisis plunged the US, EU, Japan and other developed countries into recession, their market demands decreased drastically, thus leading to a sharp decline in China’s exports. To mitigate the impact of the dropped exports on the national economy, the Chinese government adopted a positive stimulus package to expand public investment. Starting from 2009, China’s energy and resource imports grew rapidly, making it the world’s largest importer after the US. Thanks to the appreciation of the yuan, imported goods became cheaper, which helped curb inflation in China.
3. A stronger yuan will create friction between the US and China.
Facts have shown that China has never intended to sharpen its competitive edge by undervaluing its currency. When the yuan was pegged with the dollar and was meanwhile overvalued, China’s exports didn’t suffer. And when the yuan appreciated, the US suffered a large trade deficit with China. That only proves once again that the two economies are highly reliant on each other. It also attests to the absurdity of the allegation that Beijing manipulates its currency. The issue has been nothing but an excuse used by some US politicians to stoke up fear of “China threat.”
China’s imports kept growing in recent years, leading to a reduced surplus in its international current account. In 2008, that surplus accounted for 10 percent of the GDP. In 2013, however, it plunged to account for only 3 percent and may continue to fall to 2 percent this year. Given these changes, American politicians would no longer find it easy to label China a currency manipulator.
China replaced the US to become the world’s largest trading nation in 2013. China’s imports also make up a larger percentage of the global economy. The US imported $2.27 trillion of goods in 2013 while China imported $1.9 trillion. It is likely that China will surpass the US in 2015 to become the world’s largest importer.
As China has become one of the largest importing nations, its currency is bound to gain a larger influence. In 2013, the amount of China’s imports and exports that was settled with RMB accounted for a much larger share – reportedly one fifth – of the total number of trade deals than it had previously. As the Chinese government has decided to let the RMB be internationalized, more and more overseas cities have joined the mission to become an RMB offshore market, with Hong Kong leading the pack followed by Singapore, London, Frankfort, Paris and Luxemburg. Everybody wants a share of the pie.
However, the yuan is not mature enough to become an international reserve currency. China needs to open its financial market wider. The opening of capital accounts is the touchstone for the yuan internationalization. In international monetary studies, there is an Impossible Trinity theory, which states that a country cannot hold an independent monetary policy, a free capital flow and a stable exchange rate at the same time, and that the realization of any two targets must be based on the abandonment of the remaining one. China will open its capital account and must maintain its independent monetary policy, so it has to give up the fixed exchange rate to allow a free fluctuation of its currency. At present, with the capital account becoming gradually opened, the yuan is floating at a larger and larger margin. During this course, however, the yuan may depreciate, as was the case not long ago. Some American politicians may continue blaming China for currency manipulation but they won’t have more opportunities to do so.
In fact, China knows well that artificial depreciation of currency is not a beneficial deed. It may stimulate exports but a more open financial market will create greater opportunity for foreign investors to buy domestic asset at lower prices. Besides, to become a currency favored by foreigners, the yuan has to acquire a strong, stable buying power. A constantly depreciating currency wouldn’t win their favor. Therefore, in the future, Americans may not worry about the yuan being undervalued but will rather worry that a rapidly appreciated yuan would erode the dollar’s supremacy and thus share the benefits enjoyed by the traditional international reserve currency.
Ding Yifan, Deputy Director, Research Institute of World Development, China Development Research Center (DRC).
This article was first published at Chinausfocus.com To see the original version please visit http://www.chinausfocus.com/finance-economy/the-rmb-exchange-rate-and-sino-us-ties/
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