Download Relationship of Sino-US Trade Balance and RMB Exchange Rate

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Relationship of Sino-US Trade Balance and RMB Exchange Rate
WANG Lin1, 2
1. School of Economics, Huazhong University of Science and Technology, P.R.China, 430070
2. School of Economics and Management, Huazhong University of Science and Technology Wuchang
Branch, P.R.China, 430070
[email protected]
Abstract: Based on annual data from 1994 to 2005, the paper showed that RMB exchange rate
appreciation have influence on China-US trade balance in the long run to a certain extend but not the
main reason for China-US trade imbalances through cointegration analysis and Granger causality test.
Development of U.S. economy and domestic policy in U.S. can be said to the main reason for China-US
trade surplus. In the current economic situation, China-US trade surplus is still one of the important
engines of economic development. So U.S. economic downturn leading to the decline in our exports has
to be guarded against. On the other hand, the opportunity of RMB exchange rate appreciation can be
utilized to adjust our economic structure and accelerate the pace of industrial upgrading.
Keywords: Sino-US trade balance, RMB real exchange rate, VAR model, Cointegration, Granger
causality test
1 Introduction
Since exchange rate reform in July 2005, the exchange rate of RMB against US dollar has taken on a
trend of slow rise on the whole and presented sometimes the two-way fluctuating feature of “rising and
falling”. Meanwhile, the twin surplus of China's international balance of payment, especially the
influence of exchange rate on trade, has always been the hot topic for policymakers. From 2005 to the
end of 2008, nominal exchange rate of RMB against US dollar appreciated 15.22% cumulatively. In
recent years, the increase of US trade deficits scale has caused the United States to pay further attention
to the issues of Sino-US trade. On the one hand, the United States imposes restrictions on the import
volume of Chinese goods by various means of dumping investigation and technical trade barriers,
resulting in the increasing trade conflicts between the two countries. On the other hand, the United
States imposes pressure on the appreciation of RMB exchange rate on the ground of relieving US trade
balance.
The domestic studies on RMB exchange rate and trade balance relations mainly focus on the influences
of adjustment of exchange rate values on trade balance. With data of 1978 to 2000, Xie Jianguo and
Chen Ligao (2002) drew the conclusion that the depreciation of RMB exchange rate had no significant
effects on the improvement of China’s trade balance by using the methods of cointegration analysis and
variance decomposition. Through the analysis of the data of 1981 to 1995, Dai Xiangzu (1997)
concluded that the sum of import and export elasticity of exchange rate was 1.3, meeting
Marshall-Lerner Condition and that the depreciation of RMB would be helpful to improve trade balance.
With the data of 1994 to 2003, Lu Xiangqian and Dai Guoqiang (2005) discovered that the effective
exchange rate of RMB had a remarkable influence on import and export by using the imperfect
substitution model. Sun XiaoChong and Song Fengming (2008) held that nationality model was more
effective and that the establishment of real exchange rate index of RMB against other countries
improved the former condition of roughly applying the exchange rate of RMB against US dollar to
analyze China’s overall trade balance.
Many other scholars have studied the relations between exchange rate fluctuation and trade balance. By
using the cross-section data of China’s 22 major trade partner countries of the year 1991 and 1995, Chen
Ping and Xiong Xin (2002) established trade gravitation model and held that the increase of exchange
rate fluctuation would lead to the drastic decrease of exports. Pan Gongyu (2007) tested the influence of
exchange rate fluctuation on the exports to China’s three major trade partners by taking the standard
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deviation of exchange rate yields as the proxy variable of exchange rate fluctuation. LI Zhibin (2009)
analyzed the short and long term relationship between RMB exchange rate and Sino-America trade
balance by employing GARCH model to estimate the conditional heteroskedasticity of RMB exchange
rate and introducing the conditional heteroskedasticity into the trade balance equation as the proxy
variable of RMB exchange rate fluctuation.
Avoiding certain limits of the analyses of some scholars and absorbing some of the enlightened views,
this paper presents the following characteristics. (1) Since trade balance and exchange rate are not in a
simple two-spot relation, other factors may have a greater influence on trade balance than exchange rate.
Therefore, VAR model is applied in this paper to comprehensively analyze the dynamic relations among
trade balance, exchange rates, Sino-US GDP multivariable. (2) Considering the appreciation of nominal
exchange rate of RMB against US dollar and the rises of inflation rates in both the United States and
China, real exchange rate is adopted to establish model for empirical analysis. (3) This paper has a
narrowed study scope. Since the general data we find are about RMB exchange rate against US dollar,
this paper will focus on the issues of Sino-America trade balance.
2 Theoretical Analysis
In the aspect of influence of exchange rate on trade, researches conducted by scholars both home and
abroad generally concentrated on whether the ML condition is set up and the J-curve effect is in
existence. flexibility under the circumstance of partial equilibrium is employed in ML condition. That is
to say, assume other conditions remain unchanged, when sum of exchange rate flexibility of exports and
that of imports is greater than 1, the rising exchange rate (Local currency devaluation) is conducive to
improve international balance of payment of a country. However, generally speaking, it is difficult to
satisfy all the assumed conditions of partial equilibrium analysis. In addition, It is necessary to judge in
an object manner whether the unchanged factors assumed in partial equilibrium analysis just pose
secondary impact that can be neglected on the analyzed conclusions. It is discovered when investigating
influencing factor of international balance of payment that in addition to fluctuation in exchange rate,
elements that directly influence international balance of payment also include national revenue,
fluctuation of which produces impact through marginal propensity to import and money stock etc.
Furthermore, the rising exchange rate (Local currency devaluation) will generate the influence of
inflation on domestic price.
Analysis of the paper is based on the dynamic integrated model presented by Lawson and Metzler,
which assimilates the absorption analysis approach of regulating international balance of payment
proposed by Alexander and identifies that the regulating function of exchange rate fluctuation on
international balance of payment depends on the operation of economic system. Followings are the two
equations for the fundamental model presented by Lawson and Metzler:
Y=D(Y, r)+X(r) X(r) –r M(Y, r)=0
In the two equations, there are two unknown numbers (endogenous variable): Y, the national revenue
and r, the exchange rate. YC and YA, national income of China and America respectively, namely,
YC=D(YC, r)+X(YA, r) X(YA, r) –r M(YC, r)=B will be taken into consideration with the reason that the
article is targeted at the relationship between Sino-US trade balance and exchange rate of RMB.
Moreover, a number of theoretical and empirical studies both domestic and international demonstrate
that it is the fluctuation of real exchange rate that indeed produces influence on the international
competitiveness of productions and macroeconomic operation of a nation, and the reason why the
currency devaluation policies can not prove effective in some developing countries in history primarily
lies in that the inflation is not effectively inhibited, resulting in rather rising than depreciation of the real
exchange rate. Therefore, the real exchange rate of RMB will be figured out with price index adjustment
in the article. That is to say, the real exchange rate will be recorded as R=e*Pf/Pd, among which e
represents nominal rate of RMB and Pf and Pd stand for foreign (Here refers to America) and Chinese
consumer price index respectively.
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Combining the aforementioned equations, it can be indicated that there is a closer relationship between
real exchange rate and trade balance. As a result, the Sino-US trade balance can be demonstrated as the
function form of real exchange rate, national income of China and that of America:
B=B(e*Pf/Pd, YC, YA).
3 Empirical Analysis
3.1 Data source and process
Sample interval: annual data from 1994 to 2008. Sino-US trade balance (B) is calculated with the raw
data of Sino-US bilateral trade published by the State Statistics Bureau (www.stats.gov.cn) of People’s
Republic of China; American price index employs the consumer price index of International Financial
Statistics on the official website of International Monetary Fund (www.imf.gov). Actual Sino-US trade
balance can be drawn by dividing the two. Sample data of empirical analysis in the paper can be
obtained through taking natural logarithm of these data.
The real exchange rate (R) can be acquired from the above-mentioned formula, namely, R=e*Pf/Pd,
nominal rate of direct quotation is obtained according to the annually average price of RMB exchange
rate published by the State Statistics Bureau (www.stats.gov.cn) of People’s Republic of China; Sino-US
price indexes adopt the consumer price indexes in International Financial Statistics on the official
website of International Monetary Fund (www.imf.gov). Take the natural logarithm after figuring out
values with the formula of R=e*Pf/Pd.
GDP of China and America (YC, YA) are calculated from annually nominal GDP of the two nations
released by the State Bureau of Statistics (www.stats.gov.cn ) of PRC; Sino-US price indexes adopt the
consumer price indexes in International Financial Statistics on the official website of International
Monetary Fund (www.imf.gov); Actual GDP can be obtained by dividing the nominal one with
corresponding price index, and then sample data of the paper can be drawn from taking natural
logarithm.
Long-term equilibrium model of Sino-US trade balance can be established as followed in the
relationship research of real exchange rate, national incomes of China and America as well as trade
balance:
LnB=C0+ C1LnR+C2LnYC+C3LnYA+ε
3.2 Variable unit root test
The ADF method is put into application in the paper to test each variable unit root. Build models with
both simultaneous intercept and trend term for data with a significant time trend; bound respectively or
simultaneously the constant term and time trend as 0 for data with indistinctive time trend. Conduct
ADF test by divisions. Select the greater lags according to the minimum AIC information criterion.
Calculate corresponding AIC and then deduct P until the minimum AIC, based on the minimum AIC the
final lags are determined. See Table 1 for the ADF testing results.
LnB
LnR
Ln YC,
Ln YA
DLnB
DLnR
DLn YC,
DLn YA
Table 1 Variable unit root test
Critical value
ADF test value
Type of test
5%
10%
C,T,3
-3.3113
-3.9333 -3.4200
0,0,1
-0.2797
-1.9709 -1.6036
C,T,0
-1.0557
-3.7911 -3.3422
C,T,1
-2.3600
-3.8289 -3.3629
-3.1928
-3.1199 -2.7011
(C,0,0)
0,0,0
-3.8838
-1.9709 -1.6036
C,T,0
-3.3629
-3.8289 -3.3418
C,T,1
-3.4448
-3.8753 -3.3883
（ ）
（ ）
（ ）
（ ）
（ ）
（ ）
（ ）
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Stationarity
Instable
Instable
Instable
Instable
Stable
Stable
Stable
Stable
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According to test results, annual data for Sino-US trade balance, MRB exchange rate, GDP of China and
America are all greater than the marginal value with the significance level of 10%, indicating the four
instable sequences. However, all the first-order difference sequences of the four sets of data reject the
null hypothesis under the significance level of 10%, namely, they are stable sequences. As a result, all
the time sequences are single and entire in the first order, that is to say, they are I(1) sequences.
3.3 Co-integration Test
Johansen Co-integration Test, which estimates the long-term relationship of all the variable on the
foundation of VAR model, is adopted because the article test co-integration of multivector. The paper
confirms VAR model as well as lags of co-integration model in accordance with unrestraint VAR model.
Selection of VAR model lags follows the AIC and SC principles. Optimal regression order of VAR(P)
can be figured out through testing different and corresponding values of them. According to the
principle, the optimal regression order of the paper is 2.
Assumed number of
CE(S)
None
At most 1
At most 2
At most 3
Table 2 Johansen Co-integration Test of Multivector
Rail
1% critical
Maximum
Eigenvalue
statistics
quantity
eigenvalue
0.967924
86.00308*
54.68150
44.71556*
0.835920
41.28751*
35.45817
23.49624
0.695774
17.79127
19.93711
15.46979
0.163539
2.321477
6.634897
2.321477
1% critical
quantity
32.71527
25.86121
18.52001
6.634897
The above results are obtained on the foundation of the linear trend of selected sequence and the
intercept of co-integration equation. Under the significance level of 1%, both maximum eigenvalue test
and trace statistic test of the model reject r=0, indicating a co-integration relationship existing among the
four variables. While it is also noticed from the testing results that there is contradiction between the
trace statistic test and the maximum eigenvalue test in a way that there are two co-integration vectors in
accordance with the former while there is only one in line with testing result of the latter, and results of
the two demonstrate that co-integration relationship is in existence.
Table 3 Estimated results of Johansen Co-integration Test
Co-integration expression
LnB= -0.493882LnR+0.338082LnYC+6.835064LnYA
(0.21795)
0.10569
0.42737
（
） （
）
According to the above formula, in the 15 years from 1994 to 2008, there exists a negative correlation
between real exchange rate of RMB and Sino-US trade balance while a positive one between real GDP
of China and America and Sino-US trade balance. It is discovered from comparing influences of
economic development of China and America on their trades that economic development of America
enjoys a prominent function on Sino-US trade balance in a way that each 1% increase of American real
GDP will generate an increment of 6.83% of Sino-US trade balance. Judging from the long-term
equilibrium, the rising of RMB real exchange rate will not pose significant influence on trade balance of
China and America.
3.4 Granger Causality Test
Johansen Co-integration Test states that there is a long-term equilibrium relationship among variables.
Granger Causality Test, which is conducted here to further test the relationship between Sino-US trade
balance and other three explanatory variables, aims to investigate the estimating capacity of one
explanatory variable on another with the basic thought as follows: For A and B, two variables subject to
stationary random process, if a more accurate predicted value can be obtained by predicting A with
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previous and present data of A and B than the same conduction without previous and current data of B,
B will be the Granger cause for A. Two lags are selected here to perform Granger Causality Test and see
Table 4 for the causality between Sino-US trade balance and each influencing variables.
Table 4 Granger Causality Test Results
Null hypothesis
Sample number F statistic
LNR is not the Granger cause for LNB
2.15992
13
LNB is not the Granger cause for LNR
0.13140
LNYC is not the Granger cause for LNB
0.09168
13
LNB is not the Granger cause for LNYC
2.02350
LNYU is not the Granger cause for LNB
4.26781
13
LNB is not the Granger cause for LNYU
0.64381
Probability
0.17780
0.87872
0.91334
0.09168
0.05479
0.54835
According to the Granger Causality Test results, there is causality among American internal revenue,
real exchange rate of RMB and Sino—US trade balance while Sino-US trade surplus marks the Granger
cause for the increasing internal avenue, suggesting that trade balance surplus with America counts an
important factor that promotes the increase of Chinese national income.
3.5 Analysis on each variable’s function on trade balance
Error variance of a time sequence is the concurrent result of self disturbance and other disturbances of
the system. Main thought of variance decomposition, the purpose of which is to study to which extent it
can influence the subsequent changes of the whole system when an exogenous shock take place in a
system, is to decompose fluctuation of each endogenous variable in the system into several components
that relate to each equation shock according to their causes so as to learn the relative significance of
various shocks on endogenous variables of the model. Variance decomposition enables us to learn the
relative importance of each influencing factor on trade balance of the two nations.
Period
1
2
3
4
5
6
7
8
9
10
Table 5 Variance decomposition results of Sino-US trade balance
SE.
LNB
LNR
LNYC
0.203079
100.0000
0.000000
0.000000
0.299365
95.28605
0.005505
0.112493
0.435996
91.98298
0.028700
1.039292
0.555757
86.09918
0.428118
0.931180
0.696633
75.08575
1.087064
0.600284
0.899590
63.17808
1.633097
0.367030
1.170459
51.67920
2.308367
0.263019
1.520050
40.88566
2.925220
0.275995
1.968176
31.31993
3.500942
0.389309
2.538783
23.19163
4.008069
0.581589
LNYU
0.000000
4.595949
6.949032
12.54152
23.22690
34.76179
45.78492
55.91312
64.78982
72.21811
Results of variable decomposition suggest that if the contribution rate of trade balance is not taken into
consideration, influence of real GDP of America on Sino-US trade balance becomes prominent with
time passing by in a way that its contribution rate on trade balance reaches over 20% after the four-year
duration of lags; Despite that real exchange rate enjoys the tendency of further enhancement with time
passing by, it does not generally pose significant influence on Sino-US trade balance. Impact of real
GDP of China on Sino-US trade balance fluctuates within a small range with very little influence. To
sum up, fluctuation of American real GDP marks the most significant reason influencing Sino-US trade
balance.
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4 Conclusion
The paper establishes co-integration model of Sino-US trade balance and analyzes with approaches such
as Granger Causality Test and variable decomposition etc. influences of related factors including
exchange rate on Sino-US trade balance, demonstrating that:
(1) There exists a long-term equilibrium relationship between Sino-US trade balance, national income of
China, national income of America and the real exchange rate of RMB.
(2) In the long run, favorable balance of trade between China and America, with rich flexibility
(long-term flexibility is 6.83), enjoys significant positive correlation with internal income of America,
indicating that the import demand of America resulted from its rapid economic growth will increase
Sino-US trade surplus.
(3) In the long term, influence of RMB exchange rate change on Sino-US trade balance produces some
certain duration of lag without significant impact. Sino-US trade imbalance is the macro demonstration
of the imbalanced economic structure, and China’s saving glut as well as deficit spending policy of
America contributes to the trade deficit of America. In addition, exchange rate produces different
mechanism of action on China, America and other countries. Big changes in the real exchange rate,
primarily come from relative changes of CPI in the two nations, have not been witnessed from 1994 to
July 2005. That is to say, instead of originates from nominal rate, influence of real exchange rate on
trade comes from relative changes in inflation.
(4) In the long term, national income growth of China, influence of which on trade balance is not
notable, and not the Granger cause for Sino-US trade balance. In other words, trade deficit of America,
which is largely due to domestic reasons in America, and is not likely to be improved by depending on
economic growth in China.
(5) Sino-US trade surplus is the Granger cause for the growth of national income in China,
demonstrating that China’s economic growth remains primarily driven by investment and foreign trade.
America, which has always been the leading target country for export of China, plays a crucial role in
the economic development of our country.
In a word, it is can be said that Sino-US trade balance surplus is resulted from functions of various
elements such as characteristics of the international division of labor, domestic policies of both China
and America and the feature of economic growth in China etc.
Both reasonable and unreasonable factors exist in Sino-US trade imbalance. The reasonable factors are
determined by the current characteristics of international division of labor. A major shift in global
manufacturing industry is taking place under the influence of economic globalization, and China
continues to maintain its status as the hub of global manufacturing industry. Most labor intensive
industries of developed countries from Europe and America are shifting to China, directly resulting in
large trade surplus between China and America. Unreasonable factors deserve our special attention and
seeking for solutions. In addition to trade policies such as tariff and non-tariff policies that often
mentioned, crucial unreasonable elements also include domestic economic policies both in China and
America. There are three typical policies in America, namely, fiscal policy of high deficit, policy of high
consumption and export control policy. However, China, whose current domestic saving rate is too high,
enjoys insufficient domestic demand as well as low cost of human, resource and environment, directly
leading to the fact that our national productions have to find ways out in foreign market and
continuously increasing trade surplus.
Therefore, aiming at the point of views discussed above, It is not necessary for China to reduce export
and trade surplus on purpose, which runs against market laws with the reason that China’s pattern as the
center for labor and manufacturing industry will not change currently as well as some time in the future,
which is a reasonable element formed by the aforementioned market resources allocation. Moreover,
intentionally reducing export is not conducive to countries of consumption. Import may be enhanced
through proper appreciation of RMB, in particular, purchasing a large number of technologies at
relatively low price and regulating domestic economic structure in an initiative manner at the stage of
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industrial updating in China. Furthermore, under the influence of US economic downturn and weakened
external demand while domestic credit growth, price inflation of agricultural productions as well as
elements of labor force, land and resources etc. and increasing inflationary pressure in China, we should
accelerate domestic economic structure adjustment, making China the country whose economy increase
is driven by internal demands.
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