A Study On Why The United States Must Be Cautious In Attempts To Accelerate Appreciation Of The Rmb

A STUDY ON WHY THE UNITED STATES MUST BE CAUTIOUS IN ATTEMPTS TO ACCELERATE APPRECIATION OF THE RMB CHAPTER ONE 1.1 INTRODUCTION Napoleon once stated that, “When China wakes, it will shake the world.”1 Since Deng Xiaoping’s declaration of an “Open Door Policy” in 1979, the Chinese economy has experienced tremendous economic growth that has been unmatched by any modern country In addition, the way at which the country has sustained record growth over a relatively constant period is remarkable This incredible growth has not only been beneficial for China, but also essential for the United States and numerous economies throughout the international community According to the U.S.-China Business Council, China’s real Gross Domestic Product (GDP) grew 10.7 percent in just 2006 alone.3 This level of economic expansion in one year equates to the aggregate growth many countries would amass over an entire decade Also impressive is the fact that, less than a decade ago, China was the seventh largest economy before surpassing Italy, France, and the United Kingdom Furthermore, when you consider purchasing-power parity (PPP) of this budding economy, by most measures, China is regarded as the second largest economy Taking these facts into account, there should be no doubt that China’s economy is awakening, and as the world’s fourth largest economy behind the United States, Japan, and Germany, China still has ample room for expansion Gittings, John (2005) Half a Superpower: pg 134 Deng Xiaoping was a prominent Chinese politician and reformer, and the late leader of the Communist Party of China (CCP) Deng never held office as the head of state or the head of government, but served as the de facto leader of the People's Republic of China from 1978 to the early 1990s See General and Financial Indicators of the People's Republic of China See Walker, Marcus (2007) China’s GDP Poised to Top Germany’s as Power Shift Speeds Up In recent years, China’s thriving economy has also begun to produce an unprecedented number of middle class families As a result, the average Chinese today has some ten times the purchasing power they had just a quarter century ago Many analysts believe that at this rate China could potentially reach the purchasing power of the U.S in about two decades and surpass the economic superpower in about three decades 1.2 STATEMENT OF THE PROBLEM While China is enjoying economic expansion, a growing middle class, and increased trade relations, the United States is simultaneously experiencing quite the opposite phenomenon Moreover, the United States, through a robust bilateral economic exchange with China over the past decade, has experienced an unprecedented trade deficit, increased levels of unemployment, surging energy costs, and a middle class that appears to be shrinking due to widening disparities between the rich and poor As a result, more and more lawmakers and policy analyst have become frustrated with economic policies that appear to give China an unfair advantage over the U.S., thus increased attention is now focused on the way at which China is regulating its currency Given that a significant deceleration of the Chinese economy is not expected in the near future, there are important currency valuation issues that should be addressed to ensure a more balanced U.S.-Sino relationship Many policy makers believe that an undervalued renminbi7 (RMB) is harmful to the U.S economy and more specifically the running U.S trade deficit with China.8 Indeed, increased trade with China plays a See Faux, Jeff (2006) The Global Class War See The Economist (2002) To Get Rich Is Glorious The renminbi is the currency of the mainland of the People's Republic of China whose principal unit is the yuan See Morrison, Wayne & Labonte, Marc (2008) China’s Currency: Economic Issues and Options for U.S Trade Policy significant role in decreasing the cost for many goods sold throughout the United States, which simultaneously benefits both the American and Chinese economies However, an extremely undervalued currency has augmented the steady and overwhelming flow of cheap goods from China and has made it difficult from U.S companies to compete It has also been argued that since an undervalued RMB equates to cheaper goods and services, this in turn directly affects the American worker by placing tremendous downward pressure on their wages With that said, if China intends to become a trusted international player, it will need to revalue its currency and implement a more flexible exchange rate that is fair and reflective of market forces However, some economists not agree that China’s valuation is the problem behind many of the concerns facing the U.S economy In fact, there is concern that U.S pressure to encourage China to appreciate the RMB could actually be detrimental to China’s growing economy In addition, there is concern that the impact of an ailing Chinese economy, as the result of a failed currency policy, could impact many economies throughout the international community Thus, the stakes are too high for China and the U.S to assert a currency policy that is overly ambitious and potentially too aggressive Therefore, it is important to know where China is headed with what some perceive to be its manipulative economic policies; what are the country’s intentions; what could aggressive pressure from the West mean for US-Sino relations and could this lead to an inevitable collision? The goal of the research involved in this thesis is to find answers to these important questions by providing the reader a historical analysis of the evolution of the RMB as well as an assessment of the currency regime China currently employs The scope of this study focuses on the current policy debate in Washington as it relates to China’s currency valuation and the approach that the U.S should take with regards to addressing this issue In addition, it is the intent of this thesis to dissect the dichotomy of views from the various interests groups and think tanks as well as the very different policy prescriptions proposed between the Executive and Legislative Branches of government This thesis topic comes at an important time as the international community becomes ever more integrated and the possibility for crisis is augmented To this, as China continues to grow and develop into a dominant fixture within the international community, the U.S will have to contend with this fact within its policy recommendations In addition, given that China’s influence continues to grow, the stability of the global economy will become even more contingent on the economic policies that are implemented from Washington and Beijing Hence, the topic of this thesis aims toward offering an understanding that a balanced and mutually beneficial economic relationship is essential for both countries and the global economy The principle argument of this thesis advocates for a balanced policy that maintain steady political pressure on China for its continued commitment to a gradual yet steady appreciation of the RMB In addition, this thesis argues that the U.S must push for a policy that will not only prevent the potential for instability but which assists the continued growth of both economies Lastly, this thesis finds that the range of policy proposals that have been introduced are all well intended and aim toward a common objective However, policies that advocate for a hasty appreciation of the RMB through retaliatory measures can be excessive in nature and research throughout this thesis proves that they potentially run the risk of exacerbating the possibility for an economic crisis 1.3 LITERATURE REVIEW As speculation regarding the likely benefits or impairments, as it relates to China’s unprecedented growth, continue to increase, more and more analyst are beginning to provide important research into this phenomenon which is still evolving before our very eyes In addition, Congress has become more aggressive in its approach toward establishing innovative policies aimed at reconciling the discrepancies that lawmakers perceive to be the cause for China’s surplus in contrast to a mounting U.S deficit This increase in interest has provided a plethora of prior research that provides a record of ideas and policy prescriptions, which were beneficial in guiding the assumptions and primary argument of this thesis In an effort to equally scrutinize the dichotomy of views towards U.S economic policy with China, this thesis includes research from notable conservative and liberal think tanks alike Think tanks of particular interest were those that contribute to the leading views, which permeate throughout our foreign policy such as the Rand Corporation, Center for American Progress, the Heritage Foundation, and the Brookings Institution As a result of this particular focus, the stark differences between the more labor focused and business opinions and philosophies as it relates to their proposed courses of action concerning China’s currency regulation became abundantly transparent The information and proposals provided by the think tanks who focused more on labor were more inclined to advocate for cautious interaction with China They were in fact more likely to draw attention toward the gloomier side of U.S involvement with China and never missed and opportunity to highlight the adverse effects created as a result of the relationship between the two countries.9 However, the investigative research that they provide makes significant contributions in analyzing indisputable problems that pose significant threats if China continues to allow the RMB to be undervalued As a result, Center for China Currency Coalition and the Economic Policy Institute for example, tend to advocate for more protectionist measures concerning trade in addition to harsh punitive measures created in and effort to essentially force China to immediately revalue the RMB and enact a more free-floating currency Some economists such as Nicolas Lardy for example, appear to be uncompromising at times in their criticism toward China and its currency regime However, they provide strong reasoning as to how serious the affects are to the U.S concerning the undervaluation of the RMB Yet, this thesis finds that their proposed courses of action lean more toward retribution instead of reconciliation This could pose the risk of harming the Chinese economy, which is still developing, and some economists believe that the RMB may not be ready to float freely and manage the complexity of a free market Indeed, China has shown that it is trying to make cautious reforms in an effort to head in the direction that the US would prefer, but hasty and premature moves could prove detrimental for this economy and U.S.-Sino relations To that end, this thesis found the more labor focused interest groups to be extremely helpful in providing a thorough assessment of the problems the U.S faces with China’s slow embrace of full reform, but falls short of endorsing any particular policy See Bivens, Josh & Scott, Robert (2006) China Manipulates Its Currency- A response is Needed In contrast, some of the more business-focused think tanks have a propensity to rely heavily on market forces as opposed to what they deem, drastic government intervention They also tend to assert the need for a moderate approach that actually focuses less on China as the sole problem and more on the need to assist its economy as it gradually evolves In fact, the idea that quick action on behalf of the U.S could backfire, for example, is a leading theory that advocates for a more cautious approach toward dealing with China’s currency valuation.10 The research from these interest groups was extremely helpful in understanding the reasoning behind China’s resistance to hasty reform It also provided balance to this thesis by highlighting the many benefits the economic relationship offers the U.S It is important to note however, that both the labor and business focused think tanks and interest groups recognize that there are challenges with regards to China’s currency regime While they tend to differ in their demonstration of the severity of the challenges, both however, propose solutions that are essential in trying to create a balanced approach to deal with this issue In addition to think tanks, when you consider the policies of the Executive branch versus that of Congress you find that there are clear differences between the two branches of government Many analysts have observed that whether there was a Democrat or Republican in the White House, there has been a difference in views between the two branches.11 However, similar to the competing views of various think tanks, both branches have well intended solutions for a common problem This thesis takes advantage of the abundant resources from government agencies such as the 10 See Overholt, William (2007) The Cost of Unleashing China’s Currency See Bader, Jeffery & Bush, Richard (2008) Contending with the Rise of China: Build on Three Decades of Progress 11 Congressional Research Service and the U.S.-China Economic and Security Review Commission, which provide detailed reports of U.S interaction with China This data is particularly important as it provides up-to-date analysis, which is critical to preserving the relevancy of the research provided in this thesis Lastly, it is important to note that this thesis includes economic statistics and data primarily based on information from the Chinese Government, which is known to misrepresent or misreport some of its economic data This is a limitation faced by all researchers and analysts examining the Chinese economy Although the reliability of the data is somewhat questionable, it is the best and sometimes the only economic information available for an analysis of this type The Heritage Foundation Report, The 2008 Index of Economic Freedom, ranks China 126th out of 157 countries whose economies were assessed for economic freedoms.12 In addition, the Heritage Report ranked China 23rd out of the 30 countries in the Asian-Pacific Region The lack of transparency this represents provides a level of difficulty with regard to gathering economic data upon which to base sound conclusions on China's economic progress It also represents another problem that China must addresses as they strive to become a market economy Nevertheless, the arguments and overall conclusions in this thesis are based on a compilation of research, records, data and an analysis that does not only rely on the figures provided by official Chinese government sources 1.4 THESIS OUTLINE China’s currency structure is complex and thus, fully comprehending the dynamics require the reader to understand how it evolved to its current form Therefore, this thesis begins by providing the reader with a chronological account of the stages at 12 See The Heritage Foundation (2008) Index of Economic Freedom which China’s currency regime has developed The scope of this assessment focuses solely on the era of reform, which began in 1979, as this was the period when China initiated its first major currency reform after Deng Xiaoping’s economic reforms Upon garnering an understanding of China’s currency evolution, the reader will become familiar with the three major exchange rate reforms, the dual exchange rate, fixed or pegged exchange rate, and currency basket regime As a result, the reader will also be able to understand the intricacies of the current system in place Chapter two is particularly important because it establishes the foundational knowledge of China’s exchange rate policy, which will enable the reader to properly evaluate and judge the opinions and recommendations of critics and leading policy makers provided throughout this thesis Chapter three provides an assessment of the policy implications that China’s currency valuation present to the U.S economy This chapter includes an overview of the leading theories and assertions as to the exact effect, good and bad, that China’s economic policy has on the American economy, specifically jobs and the mounting trade deficit As such, the reader could find this section to be subjective in nature as it displays views that are prominent within the liberal and conservative mainstream respectfully Chapter four includes a detailed case study that evaluates Japan’s similar experience with U.S pressure to appreciate its currency during the 1970s and 1980s This includes a detailed historical evaluative of the major policies that were implemented in an effort to provide a remedy for the U.S.-Japan imbalances during that time The effects of these polices on Japans economy is also examined Furthermore, this case study yields strong inferences from which it is possible to postulate the potential effects that premature and hasty appreciation may have on China’s economy and long term development The accumulation of research provided in this section is valuable and offers the reader an understanding of what options are plausible and what decisions could backfire according to history and prior attempts The remainder of this thesis focuses on the primary purpose of this research, which is to observe the policy options and opportunities that could provide the best way forward toward a balanced and mutually beneficial relationship between the U.S and China Accordingly, chapter five evaluates the positions and proposals from both the Legislative and Executive Branches of government The reader will find in this chapter that there are a number of legislative remedies that have been introduced, yet due to various circumstances, have not become law However, the emergence of such legislation indicates a problem, and the fact that many of the bills have not become law reveals that there is some reluctance to move forward As such, chapter five attempts to provide an answer to this issue by also inquiring into the position of the Executive Branch and remedies that is currently at play Upon doing so, the reader will soon understand that both branches have differing views regarding the best way to move forward with the growing concern of China’s currency regulation thus, aggressive legislative prescriptions have been kept at bay This thesis closes by restating the intended proposal of a balanced policy that continues to take moderate measures to keep China moving toward a free-floating currency while also giving it the time necessary to maintain a stable economy Upon concluding this research thesis, the reader should have a thorough understanding of 10 intended to compel China to appreciate immediately may only damage U.S.-China relations Japans example during the 1990s demonstrated how quickly tensions can rise when retaliatory measures are undertaken To prevent a similar event with China, the U.S must take full advantage of the SED that brings both countries together twice a year to address freely any concerns and frustration Moreover, the economic relationship between the U.S and China may prove to be one of the most important collaborations in the near future and it is incumbent upon both countries to ensure continued cooperation If China is intent on being a leading economy within the global community, it must its part in furthering the reforms necessary to become a market economy Indeed, its evolution has been gradual and rightfully so, but as Secretary Paulson recently mentioned, appropriate appreciation is in China’s best interest as its economy continues to grow.133 To some extent, China’s economy could be compared to a grown adult still living at home and depending on its parent’s resources At some point in your adulthood, you are expected to move out of your parent’s home, make your own living, and not depend on someone telling you what to A great deal of frustration builds when China appears to employ a currency regime not intended for a mature economy In addition, the currency basket makes China appear dependent on other countries currency, some of whom, China has surpassed in growth If China intends to be a major economic power, it must lead by example, beginning with revaluing its currency and allowing it to float freely in a market economy As China’s economy matures, necessary changes and reform should not come as a result of U.S pressure 133 See Zwaniecki, Andrzej (2007) Treasury’s Paulson Pledges to Keep Pressing China on Currency 99 The case study in Chapter four yielded strong inferences that contributed significantly to the final conclusion of this thesis Admittedly, the positions and arguments of this thesis changed many times This is because the issue of China’s currency reform is a difficult topic from which to study However, the insight provided from the historical evaluation of Japan’s experience provided very convincing evidence that steady and gradual appreciation is in the best interest of an economy that experienced similar growth The most convincing evidence presented in the case study placed into question the primary and fundamental argument made by advocates for accelerated appreciation The trade deficit is always elaborated upon by many critics who believe immediate appreciation will result in a simultaneous decrease in the U.S trade deficit with China However, as figures 4.2 and 4.3 in chapter four illustrated, as the U.S trade deficit with Japan slightly decreased following Japans dramatic appreciation, it never reduced to a complete level In fact, Japan still runs one of the largest surplus’ with the U.S It is a fair and general assumption that the appreciation of the Japanese yen following the “Nixon Shock” and Plaza Accord agreement were intended to bring longterm balance to the U.S.-Japanese economies Nevertheless, following the Nixon Shock in the 1970s, the U.S trade deficit later increased rather exponentially during the 1980s.134 Moreover, as the U.S faced another increased trade deficit, the plan was again to increase the value of the yen against the dollar While this of course lowered the trade deficit, it did so only temporarily Further examination of the case study also illustrated how the U.S trade deficit not only increased with China, but it also expanded with the rest of the world As 134 See Solarz, Stephen (1982-83) A Search for Balance pg 76 100 mentioned earlier, this represented an increase in U.S domestic consumption Therefore, as Japan’s currency appreciated, the cheap goods of China and other countries with similarly lower valued currencies fed American consumption This provided sufficient evidence to the case that if China were to appreciate dramatically the RMB, it could be expected that the trade deficit will be redistributed to other countries with cheaper currencies Why not work with China toward gradual appreciation that enables stable economic growth on its part It has over one billion consumers who, as their lifestyles and standards increase, would have the potential to afford many goods made in America If U.S policymakers are thinking long term, a continual economic alliance and bilateral exchange would almost certainly provide a sizable return At the present time, concern about the U.S economy is rightly addressed and very much legitimate The U.S is in uncharted waters with such a massive trade deficit with China In addition, the economic outlook, as mentioned earlier, is not where many would prefer While a sizable portion of the deficit has a lot to with increased consumption, China’s undervalued currency also plays just as important of a role To this, just as this thesis advocates for U.S policy that gives consideration to China’s economy, it also has a responsibility to work with the U.S in an effort to address this issue First and foremost, China must continue to tackle the issue of its undervalued currency by appreciating the RMB at a steady rate In addition, it must also increase the band from which the yuan floats against the dollar to allow more of an increase in value These two efforts, while they will not have an immediate effect on the U.S trade deficit, 101 they would ensure a gradual expansion of the Chinese economy that should yield future returns for the U.S China must also work collaboratively with the U.S to increase its domestic consumption levels While this is one of the long-term goals of the SED, aggressive measures should be taken as their economy expands.135 With an increased value of the RMB, American goods would become more affordable in China If efforts are made to increase consumption at a much greater rate as the RMB appreciates, both economies would benefit as increased trade and further collaboration would be the result Lastly, there are a number of other topics that while not directly tied to the issue of currency valuation, play a significant role within the U.S.-China bilateral exchange More specifically, issues such as sovereign wealth funds, WTO and IMF agreements, and China’s lack of transparency for example, must be addressed along with China’s currency reform This thesis did not include much about either topic solely due to an effort to provide proper attention to the effects of an undervalued RMB In addition, while this thesis argues for patience with regards to currency reform, it does not dismiss the fact that there are a number of legitimate concerns that pose significant threats to the U.S economy That is why continued dialogue and engagement through the SED is so critically important It is essential that both countries come to the table in order to gain a better understanding of the challenges that both economies face Unilateral action such as aggressive legislation from Congress could hinder the continual progress being made from engaging China directly on the issues that we find challenging in the U.S China has the potential to be a long lasting ally with whom we currently have the ability to search for remedies to challenging issues through diplomatic 135 See Department of Treasury (2006) Fact Sheet Creation of the U.S.-China Strategic Economic Dialogue 102 means The possibility of damaging this relationship through unilateral action may not be in the long-term interests of the U.S It is also important to stress the fact that the issue of China’s undervalued currency is not just a problem for the U.S As the value of the Euro increases, concerns in Europe are growing accordingly.136 Therefore, gaining the support of other economies that face similar challenges in an effort to address this issue in a multilateral approach would prove beneficial Above all else, China would at least get the point that the U.S is not the only country concerned, and other trading partners are willing to take action if it does not appreciate its currency To close, if the end result is to lower the U.S trade deficit with China indefinitely, then hasty appreciation is not answer While hasty appreciation may be attractive in the short term, Japan has showed that it is not effective as a long-term measure The U.S must take a multifaceted approach that includes constant engagement with China and the inclusion of other major trading partners China desires to expand its economy and most importantly would eventually like to become a market economy.137 It is important and in the best interest of the U.S to work with China in achieving this goal In the end, the improvement of China’s economy and the millions of Chinese people subsequently lifted 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