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The Controversy over the Revaluation and Exchange Rate Regime of the Chinese Currency 人民币均衡汇率的争议和调整方案的选择 Gene H Chang (张欣) University of Toledo, U.S.A. (美国托列多大学) 经济学教授、亚洲研究所主任 [email protected] © The U.S. Congress Senate Bill: by Charles Schumer (D., N.Y.) and Lindsey Graham (R., S.C.) Currency manipulation by China. If no RMB revaluation, imports from China can be subject to 27.5% tariff. Vote by July. Gene Chang, June 2005 The U.S. Congress House China Currency Act: by Congressmen Duncan Hunter (R., Calif.) and Tim Ryan (D., Ohio) Currency manipulation as a "prohibited export subsidy" by China, under Article VI of the GATT. If no RMB revaluation, trigger an antidumping or countervailing duty. Prohibition of importation of Chinese defense products Gene Chang, June 2005 Public • Job loss • Close of many American companies especially, small companies Selected Antidumping Actions Initiated by the U.S. Against China Date of Product Initiation Provisional Measure (Dumping Margin) Dumped Imports as % Domestic Consumption Basis of # of Firms charged Determination Antidumping Actions by the U.S. Car Windshield Glass 3/27/2001 .05-125% NA 2 firms NA Folding metal Chairs and Tables 12/3/2001 0-134.77% NA 2 firms NA Foundry Coke Products 03/18/01 76.19-214.89% NA 4 firms NME 08/24/01 NA NA 7 firms NME Freshwater Crawfish Tail Meat 26/12/01 7.23% NA 27 firms NME Heavy Forged Hand Tools (3 cases) 11/07/00 0.00-98.77% NA 5 firma NME Honey 08/02/01 22.05-67.44% NA 3 firms NME Hot-rolled Steel Flat Products 05/01/01 64.20-90.83% NA 3 firms NME Fresh Garlic cases) (3 Furniture 2003 28 firms TV sets 2003 1 firm Textile products 2005 Gene Chang, June 2005 Top trade partners of the U.S. (2004) Trade Deficit 1 Total Trade Volume Canada 2 Mexico Japan 3 China Canada 4 Japan Mexico 5 Germany Germany Gene Chang, June 2005 China Discrepancy between The U.S. and China Statistics Trade deficit with China (million$) Calculated by the U.S. customs Calculated by the Chinese customs 2004 161,977 80,200 2003 123,960 58,613 2002 103,115 42,720 Gene Chang, June 2005 US Trade with China (million dollars) 250,000 200,000 Total Deficit 150,000 100,000 50,000 19 85 19 87 19 89 19 91 19 93 19 95 19 97 19 99 20 01 20 03 20 05 0 Gene Chang, June 2005 The Bush administration -- ambivalence •2003: US Treasury Secretary John Snow told a House of Representatives panel. "China has pegged its currency to the dollar for 10 years. This administration has stressed that China needs to move to float its currency as soon as possible” •The U.S. Treasury angered Congress by stopping short of issuing a formal finding that the Chinese government manipulated the exchange value of the yuan. It concluded that such a policy by itself does not meet the statutory definition of currency manipulation. •May 26, 2005: The Bush administration stopped demanding that China let its currency, the yuan, float freely against other major currencies. "I don't think it is in our interest or in their interest in going immediately to a full float," Treasury Secretary John Snow told the Senate Banking Committee on Thursday. " Snow refused to say by how much he wanted China to revalue the yuan. Federal Reserve: --- reservation •March 2005: Federal Reserve Chairman Alan Greenspan warned if China were to let its currency float immediately, as many in the US want, it could weaken that country’s banking system and threaten the world economy •May 20, 2005 – Greenspan: “American shoppers will pay higher prices but the U.S. trade deficit with the rest of the world won't fall if China revalues its yuan currency as the Bush administration wants”. Impacts on the U.S. Pro Reducing trade deficit with China Preserving more jobs in the U.S. Gene Chang, June 2005 Con Increasing trade deficit in terms of dollars Speculative sell of dollars Pressure on the global dollar system, dollar and T bonds U.S. bonds down, interest rate up Widening financial resource gap Inflation Deterioration of terms of trade Consumer surplus loss Academic Jeffrey Frankel: Yuan 42% undervalued Lardy and Goldstein: 15%-25% undervalued Gene Chang: 19.2% undervalued Steve Hanke and Michael Connoly: No undervaluation Ronald McKinnon Robert Mundell Gene Chang, June 2005 Estimation of Equilibrium Value of Yuan Determination in the short-run Determination in the long-run Purchasing power parity E = PU.S. / PChina Relative purchasing power parity % depreciation in E = inflation U.S. – inflation China Problems with using relative PPP to estimate equilibrium value of yuan Gene Chang, June 2005 Estimation of Equilibrium Value of Yuan Real Exchange Rate (RER) RER = (E X PChina) / PU.S. If absolute PPP holds, RER = 1 Gene Chang, June 2005 Fig 1. Relative Pruchasing Power (RPP) of Currencies of Various Countries Relative Purchasing Power 10 8 RPP Fitted line Linear (Fitted line) 6 4 2 0 0 10000 20000 30000 -2 -4 GDP per capita Gene Chang, June 2005 40000 50000 Estimation of Equilibrium Value of Yuan Why is RER greater than 1 for poor countries? The Balassa-Samuelson hypothesis The Bhagwati-Kravis-Lipsey hypothesis Gene Chang, June 2005 Estimation of Equilibrium Value of Yuan Model with control of the income level: RER = f (GDP per capita) Data for RER Linear or log linear (ln) RER = a + b X (ln) GDP per capita Control heteroskedasticity Gene Chang, June 2005 Estimation of Equilibrium Value of Yuan Using the world sample to obtain the estimates and the prediction equation Intercept Coefficients Standard error 4.28039 0.15922 GDP p.c. -0.13386 Gene Chang, June 2005 0.01320 t -statistics 26.88387 -10.14495 RMB exchange rate RER actual Gene Chang, June 2005 20 01 19 99 19 97 19 95 19 93 19 91 19 89 Exchange rate (yuan per $) 19 87 19 85 10 9 8 7 6 5 4 3 2 1 0 RMB Undervaluation Estimation Year GDP pc 2001 RER actual RER predicted Valuation P-value 1978 703 1.98 4.07 51.3% 0.084 1985 1158 2.68 4.02 33.3% 0.187 1986 1293 3.21 4.00 19.7% 0.299 1987 1509 4.33 3.97 -8.9% 0.406 1991 1757 4.39 3.94 -11.2% 0.384 1994 2484 4.79 3.86 -24.3% 0.263 1995 2788 4.30 3.82 -12.6% 0.372 1996 2987 4.08 3.80 -7.4% 0.424 Gene Chang, June 2005 RMB Undervaluation Estimation Year GDP pc 2001 RER actual RER predicted Valuation P-value 1997 3145 4.01 3.78 -6.1% 0.437 1998 3308 4.09 3.76 -8.9% 0.409 1999 3522 4.26 3.73 -14.3% 0.357 2000 3829 4.37 3.70 -18.4% 0.319 2001 4020 4.41 3.67 -20.1% 0.304 2002 4309 4.48 3.64 -23.2% 0.278 2003 4618 4.41 3.60 -22.5% 0.286 2004 5024 4.23 3.55 -19.2% 0.315 Gene Chang, June 2005 -1.5 Gene Chang, June 2005 Vin cen Fij i Bo livi ta a nd Ec the ua do Gr r en ad ine s Jam aic a -1 St. -0.5 zR ep ub lic Le so tho Uk rai ne Gu yan a Ch ina Pa r ag ua y Ge org Tu rkm ia en ist an Sr i La nk a Mo roc Sy co ria Alb nA an rab ia Re pu bli Gu c ate ma la rgy Ky Under / Over –valued currencies 1 0.5 0 Should RMB be revalued? --- attitudes of The U.S. Japan European Union Rest of Asia Developing countries China itself Gene Chang, June 2005 Asian countries China is the largest export destination for many Asian regions including Korea and Taiwan China and Hong Kong imports more goods from rest of Asia than Japan Concern over a floating RMB that may cause regional economic instability. Gene Chang, June 2005 China Con Reduce competitiveness Adversely affect exports Adversely affect employment Deflation Gene Chang, June 2005 Pro Improve terms of trade Reduces debt service burden Reduces the cost of the huge foreign reserve Upgrading economic structure Choice of exchange rate regime --- Flexible Free floating – the absence of regular intervention in the foreign exchange market Managed float – the absence of a specific target for the exchange rate Note: according to Frankel, Huang and others Gene Chang, June 2005 Choice of exchange rate regime --- Intermediate Target zone, or band – a margin of fluctuation around some central rate Basket peg – fixing not to a single foreign currency but to a weighted average of other currencies 5. Crawling peg – a preannounced policy of devaluing a bit each week Adjustable peg – fixing the exchange rate, but without any open-ended commitment to resist devaluation or revaluation in the presence of a large balance of payments deficit or surplus Note: according to Frankel, Huang and others Gene Chang, June 2005 Choice of exchange rate regime --- Fixed Truly fixed peg – fixing, committing to buy or sell however much foreign currency is necessary at a given exchange rate, with a firm and lasting intention of maintaining the policy. Currency board – three defining characteristics: fixing not just by policy but by law, backing increases in the monetary base one-for-one with foreign exchange reserves, and allowing balance of payments deficits to tighten monetary policy and thereby adjust spending automatically Monetary union – the adoption of a foreign currency as legal tender. This includes the special case of official dollarization Gene Chang, June 2005 China: which choice Free floating The vulnerable monetary and banking system cannot stand the fluctuation of ER Extend the band Ineffective for a small band and inviting more speculation. A large band is equivalent to free floating. Gene Chang, June 2005 China: which choice --- target a basket of currencies Will float with dollar thus resulting a high transaction cost Difference between China and Singapore. Large country with this system: the instabilities of other currencies. Gene Chang, June 2005 Why still peg to dollar? Optimal currency area theory Transaction costs versus independent monetary policy The impossible trinity China can keep an independent monetary policy so long it restricts capital accounts Gene Chang, June 2005 With adjustment options No permanent peg Adjustment may need for changes in macroeconomic conditions Not dollarization .. Keep an independent monetary policy and seigniorage income Gene Chang, June 2005 China: which choice No perfect policy The best choice is still a one-time adjustment, then pegging to dollar again. Least risk, least cost, and easiest to operate. Adjustment of 5-7% Unannounced in advance Gene Chang, June 2005 Internationalizing yuan Internationalization of yuan in the long run Merits 1. More flexibility for an independent monetary policy 2. Low transaction cost 3. Seigniorage income Conditions 1. Good macro fundamentals 2. Greater role in the global market Gene Chang, June 2005 China: when to adjust Exchange rate adjustment is a net economic gain for China Exchange rate adjustment is also a diplomatic gain for China in the world Exchange rate adjustment is also a political gain for China. Gene Chang, June 2005 Conclusion: when to adjust Resisting the market force is a sure failure It is a choice on the ground of economic rational and gain It is not a choice on the ground of political or economic fight – a loss-loss outcome Take an action, the sooner, the better. Gene Chang, June 2005