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China's Currency: U.S. Options

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Publication Date: July 2005

Publisher(s): Library of Congress. Congressional Research Service

Series: RL33018

Topic: Banking and finance (Currency)

Coverage: China

Abstract:

In recent years, the United States and other countries have expressed, with considerable concern, the view that China's national currency (the yuan or renminbi) was seriously undervalued. Some analysts say the yuan needs to rise by as much as 40% in order to reflect its true value. Critics say that, by undervaluing its currency, China gains unfair trade advantage and has seriously injured the manufacturing sector in the United States. Chinese officials say that they have not pegged the yuan to the dollar in order to gain trade advantages. Rather, they say the fixed rate promotes economic stability. Without this, they say, fluctuations in the yuan's value could cause serious dislocations in China's domestic economy.

On July 21, 2005, China announced a new foreign exchange system which is intended, officials said, to allow more flexibility and to permit the international value of the yuan to be established by market forces. The yuan was increased in value by 2% and a "crawling peg" was introduced so that the yuan could rise gradually in value. On July 27, however, Chinese officials said that they did not intend the new mechanism to produce further increases in the yuan's valuation. Together, the two announcements have sown much confusion as to China's real intent.

The Treasury Department has urged China strongly in recent years to adopt procedures that would allow the yuan to rise in value. Congress is considering legislation that would place a 27.5% tariff on Chinese imports to the United States if the yuan is not revalued. It is not clear whether the new system Chinese officials adopted will meet U.S. expectations. A Senate vote on the legislation to impose special tariffs is scheduled for late September 2005.

The United States has pursued the yuan-dollar exchange rate issue as a bilateral U.S.-China issue. Other countries are also affected by the presumably undervalued yuan -- some more than the U.S. -- but they have allowed the United States to take the lead. In this, they stand to benefit from any changes the U.S. effects in its confrontation with China while they take none of the blame. There are at least five ways the United States could deal with the yuan exchange rate issue. Some of these would involve other countries more explicitly in the process.

First, the United States might continue pressing China publicly for further changes in its foreign exchange system in order that the yuan's value would better reflect market conditions and economic realities. Second, the U.S. could restrict imports from China pending action to revalue the yuan. Third, the U.S. might stop pressing China publicly, on the expectation that China will move more rapidly towards reform if it is not pressured. Fourth, the U.S. might ask the IMF to determine whether China has been manipulating its currency in violation of IMF rules and whether its new exchange rate mechanism complies. Fifth, the United States might refer the issue to the World Trade Organization (WTO), asserting that the United States has been injured by unfair trade practices linked to the undervaluation of China's currency and asking the WTO to authorize trade remedies (tariffs on Chinese goods, for example) aimed at correcting this abuse. This report will be updated as new developments arise.