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Policy Memorandum

Summary

Exchange rates affect the pricing of each of the countries’ imports and exports. Currency manipulation has huge impacts on global trade. There are concerns that China and other countries manipulate their currencies in an effort to increase their exports. A weak currency makes exports of goods and services cheaper, which can increase the export output as well as create job opportunities in the sector. However, there are implications to other countries, making it harder for them to export goods to these countries. On the contrary, the United States consumers that rely on the inputs from these countries benefit from the weak currencies because the cost of importation becomes cheaper. From the policies stipulated in the International Monetary Fund, the membercountries are forbidden form currency manipulation. In addition, there are also policies provided in the United States law that can address the issues surrounding currency manipulation. This paper therefore, gives highlights on the China currency issue and policy recommendations that could be adopted to solve the problem.

Background

In the past decade, China has carefully managed the value of Yuan against dollar. Some of the policy makers insinuate that China’s renminbi (RBM) is undervalued against dollar, arguing that this has given the Chinese exporters some advantage as compared to the United States exporters. Since 1994, the Chinese government started to peg RNB to the dollar until through 2005 (Staiger and Sykes 591). Since 2005, they shifted to a controlled pegging system that allowed the government to regulate the currency only ensuring that it fluctuated within a certain range. Consequently, the RMB began to appreciate until 2008, when they halted the appreciation of the currency because of the concerns that it affected the Chinese exports. In 2012, China allowed more flexibility of its currency against dollar, and increased the band in 2014. Between 2005 and 2015, the RMB was appreciated by a margin of 25% against the dollar (Nelson 8).

Furthermore, before 1994, China maintained an exchange system that consisted of fixed exchange rate and the relative exchange rate systems. The access to foreign exchange was highly limited to reduce imports to China. China began to reform its currency policies in 2005, which led to the appreciation of the RMB currency by a margin of 34% against the United States currency (Nelson 7). The surpluses on China trade have gone down with some of the analysts projecting that it would approach market value. Other analysists insist that the China currency is undervalued against the dollar, thus continue to the mounting pressure to the china government to adopt the market-based exchange rates.

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Goals and Preferences

Exchange rates play a vital role in the global trading system as the regulate import and export of goods and services. The first proposal for legislative action against the undervalued China currency issue was first introduced by Senator Lindsey Graham of North Carolina in 2003. Successive Congress bills followed until 2010, where the House of Representatives finally approved the Currency Reformation Act (Woo 83). The objective of the bills was to give instructions to the Department of Commerce to appeal against Chinese importation if their currency were not revalued. The legislation treated the undervalued China currency as an export subsidiary. Therefore, China’s policy of intervention in the currency markets has been a concerning issue as it is considered distortive to the economic and trade policies. The China currency policy benefits the Chinese government as it makes export less expensive than import. They argue that the undervaluing of the Chinese currency is the main contributor to the United States deficits with China as well as decline in the manufacturing job opportunities.

The Chinese government has implemented policies to manage the appreciation of the RMB by printing the currency and selling it for the dollar and assets in the United States. It has also put policies that managed and controlled the buying and selling of the RMB currency. The currency interventions have increased the Chinese foreign exchange reserves to approximately 40% of it GDP (Staiger and Sykes 588). Some analysist have attributed this as evidence that the Chinese government keeps the value of RMB below as compared to if it were allowed to float freely in the market (Staiger and Sykes 583). The Obama government has focused strongly on hedging against the Chinese power alongside its rent for less advocacy of Beijing’s inclusion in the regional economic, security order and political aspects. The president’s efforts lie in the expansion of government spending and building of federal reserves.

Policy Options and Analysis

Many policy makers have alleged that the Chinese government manipulates its currency to make the Chinese exports to the United States cheaper and the imports expensive than if they had been determined by the market value (Woo 63). They make arguments that although the pegged currency was necessary in the beginning of China’s economic development, it was no longer justifiable given the growth of China’s economy and the trade flows as well as its impacts on the international economy (Woo 64). In addition, the critics also allege that the undervalued currency is the main factor behind the US trade deficit with China. Some other policy makers have linked the Chinese currency manipulation to the massive accumulation of foreign exchange reserves in China (Yang, Yin, and He 123). Currently, there is high unemployment rate in the United States, which has intensified the concerns on the impacts of the Chinese currency policy. The majority of the policy makers argue that appreciating the RMB currency will boost jobs in the United States, as most analyst find a direct correlation between the trade deficit in the United States and the level of unemployment (Yang, Yin, and He 125).

The increase in the aggregate spending of cash to make investments boosts the economic size eventually. In addition, the private firms also benefit from lower interest rates caused by the trade deficit from China. In the medium term, according to the economic theory, the undervalued RMB has no effects to the United States economy, rather it shifts production away from the United States import and export competing firms to China where they can benefit from cash flows. There is no clear cut on the gains and losses in the employment and production sectors as this will vary across different regions of the economy. An analysis by the International Monetary Fund (IMF) indicates that the appreciation of China’s currency alone will have a limited benefit to the global economy, unless it is accompanied by increase in China’s consumer and expansion of the service sectors.

To some extent, Brown’s accusations against the Chinese government hold because RMB appreciation might have long-term negative implication to the United States consumers. The Chinese practice of the manipulation of its currency could be one of the reasons for the failing United States economy. For instance, the undervaluing of Chinese currency led to trade deficit with China of approximately 227 billion dollars in 2009, 273 billion dollars in 2010, and approximately 295 billion dollars in the year 2011(Funke 470). Because of the increasing trade deficit, the United States economy has continued to suffer because appreciating the RMB currency means that there will be an increase in the costs of exported products to the USA. This will have negative impacts ono the consumers who will have to pay more. In addition, appreciating the RMB would lessen the Chinese ability to purchase the United States Treasury securities, which has the potential of increase in the interest rates. Furthermore, it will also affect the manufacturing industries in the United States, this is because the manufacturing firms will be forced to shift their business to lower cost Asian countries. This will make China more consumer demand other than exporter, hence reducing barriers.

The Chinese government argues that their currency policy does not aim at causing instability but rather at fostering global economic stability (Yang, Yin, and He 120). They argue that their goals are to increase employment of its citizens. Their officials have strongly condemned the pressures mounted by the international community for china to appreciate its currency. The officials view the economic growth as a critical component in political stability and economic sustainability. The undervalued RMB currency could have both positive and negative economic implications. The majority of people agree that greater currency flexibility by the Chinese government would greatly reduce the global economic imbalances, which is the main contributor of the current global financial slowdown. In addition, on a long-term basis, the current currency reforms in China would boost the economic efficiency of the country. The Chinese government has pledged to improve the flexibility of its currency, citing that appreciating the Yuan could lead to massive job lose hence detrimental to its economy.

The United States can derive economic and political benefits from the Currency Exchange Rate Oversight Reform Act of 2013, which it misses by virtue of generally supporting an appreciation of the Chinese renminbi. Some of the policy makers have debated on the effects of exchange rates appreciation on the trade flows to the United States economy (Woo 65). For example, if China appreciates its currency, the United States’ exports to China will increase, consequently reducing China’s imports, which will cause the decline in the trade deficits. The appreciation of the dollar will have both long term and short-term impacts on the United States economy. This issue is further made complex because of China’s role in the global supply chain. China is one of the major assemblies of multinational corporations, owing to the sharp increase of the United States importing from China. Several products that used to be assembled in countries such as Japan, Taiwan, and Singapore are manufactured in China. Then, they arrive to the United States market. The firms operating in China import the raw materials for the manufacture of finished products that are then sold on the foreign markets.

Policy Recommendations

Various avenues have been sought in the effort to address the existing disagreements between the countries. Based on the multilateral trade policies, countries have set up commitments to avoid manipulation of their currencies, made within the contexts of the World Trade Organization agreements and policies. Some of the members in the 114th congress have put forward measures such as the enation of TPA legislations into law (Nelson 18). The clauses of this law include ways of addressing currency manipulation through the use of remedies that enhance transparency and cooperative mechanisms.

Furthermore, some others have put forward counter veiling laws that would restrict importation of goods from the countries suspected in manipulation of the currency. For instance, the Trade Facilitation and Trade Enforcement Act passed in 2015 by the Senate has included provisions that would improve the surveillance and international cooperation on the exchange rates. Other measures that could be adopted include the use of diplomatic measures that preserve the status quo to address the existing disagreements because labeling countries as manipulators of currency could to more adverse effects such as trade wars, which would increase the United States borrowing costs.

Seeking the International Monetary fund (IMF) intervention is also the aspect that could be adapted to solve the conflict. The IMF has the mandate of setting up policies that regulates exchange rates amongst its member countries. It also has policies that govern the code of conduct of the member countries. The code of conduct policy states that the member countries should alienate themselves from adjusting or manipulating their own currency or gain advantage over other members. However, the IMF has never publicly named any member country violationof their currency, which has made it difficult to pursue the violators. The World Trade Organization could play a role in finding solutions to the current dispute because of its relationship between the exchange rates and the business trade.

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