China's Exchange Rate Manipulation

by Ben Della Rocca and Jennie Mu

For the past few years, China has been taking serious measures to keep its currency undervalued in relation to the United States dollar. China is currently the largest holder of US Treasury bonds: the People’s Bank of China possessed 1.1735 trillion US dollars in bonds as of July 2011. In addition to buying a large amount of US Treasury bonds, the Chinese government has implemented a policy that requires all its companies to exchange the US dollars they receive in the foreign exchange market for the Chinese Yuan. In this way, the Chinese government is manipulating its currency by increasing the supply of the Yuan, making the Yuan less scarce and thus lowering its exchange rate—the price of the Yuan in other currencies.

Other nations, particularly the United States and Japan, condemn China for its currency manipulation. By continuously devaluing the Yuan, China ensures that it maintains a large trade surplus with other nations. Keeping its currency cheap makes Chinese exports cheaper to foreign consumers. Such low export prices ensure that Chinese exports always remain high and that foreign firms cannot compete in prices, creating a significant trade imbalance. This trade imbalance has caused problems for nations like the United States by perpetuating the high unemployment and low economic growth already plaguing the country. Since firms of countries like the United States cannot sell exports at the same prices as China, foreigners do not import from the United States and aggregate demand for United States products remains low.

Truthfully China has allowed its currency to appreciate somewhat in recent years. But given the massive amount of demand for the Yuan illustrated by the United States’ trade deficit with China, the Yuan should have appreciated much more had China’s government not intervened. In light of this fact, the United States Senate passed a bill this past week that increases tariffs on Chinese goods to correct the artificially made trade imbalance; this decision was a good one. The Chinese government ultimately should not be intervening in the foreign exchange market in its own self interest when doing so causes significant harm to the United States, Japan, and other nations—such actions go against World Trade Organization agreements.

Sources

“China calls for firm opposition to U.S. legislation scapegoating yuan policy.” Xinhua, October 12, 2011. http://news.xinhuanet.com/english2010/china/2011-10/12/c_131187721.htm.

Eckert, Paul. “Senate passes China yuan bill, House fate unclear | Reuters.” Reuters, October 12, 2011. http://www.reuters.com/article/2011/10/12/us-usa-china-idUSTRE79A5AO20111012.

“Idea of the Day: Tackling China’s Exchange Rate Issue Isn’t Enough.” Center for American Progress, October 7, 2011. http://www.americanprogress.org/issues/ideas/2011/10/100711.html.

McQuillen, William and Eric Martin. “Senate Triggers China Backlash as Bill Targets Yuan’s Value - Businessweek.” Busnessweek, http://www.businessweek.com/news/2011-10-12/senate-triggers-china-backlash-as-bill-targets-yuan-s-value.html.

Department of the Treasury/Federal Reserve Board. “Major Foreign Holders of Treasury Securities.” September 16, 2011, http://www.treasury.gov/resource-center/data-chart-center/tic/Documents/mfh.txt.