"China's Exchange Rate - U.S. Economy"

While searching for the relationship of exchange rates and tariffs, I came across this interesting article from the U.S. Treasury. It's a few months old but represents the clearest picture of our real trade dynamics with China, as well as others. It's well worth the read.

"China's Exchange Rate Regime and its Effects on the U.S. Economy"
by John B. Taylor Under Secretary

...The Economy of China

With this context, let me now address China’s economy and its exchange rate regime. Economic reforms in China have increased economic growth and have made China one of the largest economies in the world. China is now a major economy, and it is still growing rapidly. It is already an engine of global growth. With per capita income of only about $1,000 per year and with financial, legal and regulatory systems in need of reform, China still faces challenges in its effort to catch up with developed economies.

China’s Exchange Rate Regime

For nearly ten years now, the Chinese have maintained a fixed exchange rate for their currency, the yuan, relative to the dollar. The rate has been pegged at about 8.28 yuan/dollar for the entire period. Thus, as the dollar has appreciated or depreciated in value relative to other currencies, such as the Euro, the yuan has appreciated or depreciated by the same amount relative to these other countries.

To maintain this fixed exchange rate, the central bank of China has had to intervene in the foreign exchange market. It sells yuan in exchange for dollar denominated assets when the demand for the yuan increases and it buys yuan with dollar denominated assets when the demand for the yuan decreases. Recently the central bank has intervened very heavily in the markets to prevent the yuan from appreciating. Since the end of 2001, dollar buying has been so great that the foreign reserves held by the Chinese government have risen by $153 billion to over $360 billion. ...

....Impact on the United States

U.S. imports from China are equal to about 1 percent of U.S. GDP, or 11 percent of total U.S. imports. Although this share may seem small, China’s imports to the U.S. have been increasing rather rapidly, between 20 and 25 percent in recent years and months. In general, these imports result from China using low-skilled labor to assemble and process imported parts and materials originating in other countries-mostly from other Asian countries that have traditionally exported directly to the U.S. Consequently, the share of U.S. imports from these other countries has declined just as China’s share has increased. Asia’s share of U.S. imports has declined slightly. Much of the increase in U.S. imports from China has come at the expense of imports that once came directly from other Asian countries.

At the same time, growth of U.S. merchandise exports to China has been accelerating recently and grew 22 percent in the first 7 months of this year. Growth has been especially rapid in recent years for U.S. exports to China of transportation equipment (including aircraft engines), machinery, steel-making materials, chemicals, and semiconductors.

China has a large trade surplus with the United States. However, because China has a large deficit with the rest of the world, it does not have a large overall current account surplus. China’s bilateral trade surplus was $103 billion in 2002 with the U.S. while China’s deficit with the rest of the world was about $73 billion. Thus, China’s current account surplus was under 3 percent of GDP in 2002 and likely to decline to less than 2 percent in 2003. Many imports from China are goods from other Asian economies that are processed or finished off in China before shipping to the United States. Other East Asian economies increasingly send goods to China for final processing before they are shipped to the United States. China accounted for 11 percent of U.S. imports in 2002, up from 3 percent in 1990. Meanwhile, the combined share of Japan, Korea and Taiwan declined to 17 percent from 27 percent over the same period.

The overall trade deficit of the United States is spread across many countries of the world in addition to China. For instance, the overall trade deficit reached $468 billion last year with 1) the Americas accounting for $105 billion, 2) Western Europe $89 billion, 3) Japan $70 billion, and 4) China $103 billion. The U.S. overall trade and current account deficit is due to the excess of investment over saving in the United States. If this gap were reduced through an increment in savings, the overall deficit could shrink as would the size of the bilateral deficits. ...Continued