China, the United States and the IMF: Negotiating Exchange Rate Adjustment

Publication Date: March 2006

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Banking and finance

Type:

Coverage: China

Abstract:

In recent years, the United States and other countries have expressed considerable concern that China's national currency (the yuan or renminbi) is seriously undervalued. Some analysts say the yuan needs to rise by as much as 40% in order to reflect its equilibrium value. Critics say that China's undervalued currency provides it with an unfair trade advantage that has seriously injured the manufacturing sector in the United States. Chinese officials counter 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 that is vital for the functioning of its domestic economy.

On July 21, 2005, China announced a new foreign exchange system which is intended 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 "managed float" was introduced. However, the value of the yuan has changed little since then. Despite the publication of many studies, scholars do not agree whether or by what percent the yuan is undervalued. The wide range of estimates suggests that there is no reason to believe that any particular figure is correct. It is not clear that the U.S. trade deficit would be lower or U.S. manufacturers would benefit if China raised the value of the yuan. In the short run, U.S. producers might be able to sell higher-priced products to U.S. consumers if the inflow of Chinese goods were reduced. In the long run, though, as long as the United States is a net importer of capital, it will have a trade deficit and other countries will ultimately replace China as suppliers of low-cost goods to the U.S. market.

The Treasury Department has strongly urged China in recent years to adopt procedures that would allow the yuan to rise in value. Congress is considering legislation that would penalize China if its currency is not revalued. 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.

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 could continue pressing China publicly to raise the value of the yuan on the assumption that change will not occur without foreign pressure. Second, it could stop pressing China publicly, on the expectation that China might move more rapidly towards reform if it is not pressured. Third, the United States could restrict imports from China pending action to revalue the yuan. Fourth, the U.S. could ask the IMF to declare that China is manipulating its currency in violation of IMF rules. Fifth, the United States could 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. The WTO, in turn, could authorize trade remedies (tariffs on Chinese goods, for example) aimed at correcting this abuse. This report will be updated as new developments arise.