Chinese Currency Manipulation?

1. Chinese Currency Manipulation?

2. Chinese Currency Yuan (CNY) 元 Renmin Bi (RMB) 人民币 Jin 金 Kuan 款 Tael 两 Qian 钱 Yin Bi 银币 Kuai 块 Da Tour 大头 Da Mao 大毛 US$ = Mei Yuan 美元

3. Agenda • Brief History • How Currency Manipulation works • The Impacts of Manipulation • The Claims against China • Virtual Subsidy • Counter Arguments

4. International Currency System History • Collapse of Bretton Woods, 1971-73 • IMF 1977 Decision • Plaza Accords 1985, G5 devalue USD • 1997, Currency Speculation in Asian Financial Crisis • Euro intro’ 1999, G7 intervention 2000 • IMF 2007 Decision

5. IMF 2007 Agreement “A. A member shall avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.”

6. China’s Currency SystemHistory • Republican China (Pre-PRC), currency problems, rampant hyperinflation • 1949-78, Closed Economy • 1979-1994 FEC, dual prices, Foreign Rates • 1994 began peg at 8.28元:1US$ • 2005 ‘floated’ peg

7. July 21, 2005 “floated” the Yuan • Not really. • Government controlled rate • Max O.3% daily fluctuation* • = Managed Float / “Dirty Float” • Market determines direction, management retards pace and prevents sudden instability. May 15, 2007 updated to 0.5%/day.

8. How Manipulation* works • Prints new Chinese Yuan to make purchases of US$ assets • Chinese Government buys U.S.$ denominated assets • Excess demand for RMB is eliminated • Lowered demand = lowered value • End result: value of RMB suppressed from “naturally” occurring market price. * Distinction between management and manipulation is disputed.

10. Impact of Currency Manipulation(on U.S.) • Increase U.S. trade deficit • Negatively affect U.S. businesses • Chinese imports relatively cheaper • U.S. exports to China relatively more expensive • Downward pressure on U.S. interest rates (caused by increased investment in U.S. assets) • Capital inflows • Chinese purchased U.S. Treasury bills fund government deficit spending • Compositional shift in U.S. economy Distortion to “Free Market Conditions”

11. Impact of Currency Manipulation(on China) • ‘Virtual subsidy’ • Reduced risk for investors ($ peg) • Increased competitiveness for FDI • Higher cost foreign consumer imports • Higher cost of imported factor inputs (machinery, raw materials, component parts) • Lower local wages, Higher employment • Expanded Yuan supply, easy credit, non-performing loans. Impedes efficient allocation of resources

12. Who Benefits? • Foreign/US firms exporting from China (400 of Fortune 500) • US consumer (cheaper goods, higher purchasing power) • Component importers from China (resources, machinery, capital inputs, etc.) • Chinese Economy (manufacturing base, economic growth)

13. Who Loses? • US firms who compete with Chinese imports (US dom. manufacturing) • US Exporters trying to get into Chinese market • Chinese consumer, individual (wages depressed, low competition) • *** US firms doing business solely in Asia – profits reported in US$; Kodak/Dell case

14. Impact“Production Platform China” • China runs trade deficit with all other nations (minus US, China has total deficit of 55Bil in ‘06) • Foreign firms own 50% of export manufacture companies in China • Capital gains from Chinese exports therefore go to foreign (U.S.) firms • U.S. firms lobby to protect this investment

15. The Claims on China • Intentionally Suppressing RMB value • Fueling economic growth/boom • Suppressing local consumers • Flooding U.S. markets –“dumping” • Undervalued by 10%-40%

16. What 40% undervalued means • At current ‘Managed’ Exchange Rate • 1USD = 7.54424 RMB • 1RMB buys 0.132552 USD • If actual value 40% higher? • RMB would buy 40% more • 1RMB = 0.185572 USD • 1USD = 5.38874 RMB

17. Counter arguments • Can only impact temporary slowing of market effects (=<30 days) • Guessing actual value “tricky Business” • Manipulation only slows effect, long run the “invisible hand” balances out.

18. Movement This Year

19. Virtual Subsidy – Case Study(US Automakers Claim) 2007 Toyota FJ Cruiser v. 2007 Jeep (Chrysler) Wrangler JKU

20. Virtual Subsidy – Case Study • April 2007, Automotive Trade Policy Council (Daimler Chrysler, Ford, GM) calls on G7 Finance Ministers to address imbalance in Yen Exchange Rates • Claim • should be trading at 100¥:1USD • U.S. automakers in effect face a $4,000 subsidy on Japanese made cars • How does this work?

21. Toyota FJ Cruiser • US market MSRP $22,545.00 • Manufactured entirely in Hamura, Tokyo, Japan. • All factors of production in Japan so MSRP is based on production inputs in ¥ • So that MSRP is actually ¥2,682,855 divided by April 2007 exchange rate of ¥119:1US$ to get the MSRP of $22,545 in the U.S. market.

22. Jeep Wrangler JKU • US market MSRP $21,190.00 • Manufactured entirely in Toledo Ohio, USA. • All factors of production in USA so MSRP is based on production inputs in US$ • So that MSRP is actually $21,190.00 MSRP for the US market is completely unaffected by foreign exchange rates with any currency.

23. Virtual Subsidy? At ¥100:1US$ MSRP ¥2,682,855 MSRP $21,190.00 $26,828.55 in US$

24. Virtual Subsidy? At ¥100:1US$ MSRP ¥2,682,855 MSRP $21,190.00 $26,828.55 in US$ At ¥119:1US$ MSRP ¥2,682,855 MSRP $21,190.00 $22,545.00 in US$ $4,283.55 in US$

25. Virtual Subsidy – Case Study 2(Anti-China Lobby Claim) Chinese Manufacturing Advantage

26. Thomas the Tank Engine(Lead-based paint optional) • MSRP $9.89ea. • Manufactured entirely in China, therefore MSRP based on factors of input in RMB • Current Exchange rate 1US$:7.54RMB • So actual MSRP = 74.61RMB expressed in US$ is $9.89ea.

27. Thomas the Tank Engine • If overvalued at 40% (“The Big if”) • Exchange rate would be: 1US$:5.39RMB • The same MSRP = 74.61RMB expressed in US$ would be: $13.84ea.

28. So What? • Your cost goes up from $9.89 to $13.84ea. • You pay 39% increase? OR, according to US manufacturing lobby • A US firm can make Thomas locally for less than $13.84ea. • Thus manufacturing and the related jobs return to the U.S.

29. Loss of Manufacturing to China? • Are we losing manufacturing jobs to China? • Has currency manipulation caused, or exacerbated that loss?

30. A drop in US Manufacturing Employment?

32. Long Term Trends in Manufacturing

33. Due to Competition, or Productivity?

34. Chinese Argument • Our developing economy is unstable • Currency management necessary to prevent crisis that would impact world economy • Must wait until further market reforms (SOE conversions, etc.) are complete • Chinese banking system underdeveloped • Vulnerable to currency speculation (Thai Baht 1997) • Political risk: currency up? > income down > employment down > worker unrest > domestic political challenge/crisis = Internal Affairs

35. Chinese Argument • Whaaaaa, Boo-hoo • We’re a Third World Nation • Stop Beating us up • American Bully!

36. U.S. Policy Implications • Legislative Action • Require reporting • Require negotiations • Institute tariffs to counter ‘virtual subsidies’ • H.R. 1002 (Spratt), S. 1586: 27.5% tariff on Chinese goods • Prohibit US DoD purchases from China • Ban federal procurement from the country • Report to IMF • Clarify definitions, remove intent, • Manipulation vs. misaligned

37. Questions?