Economic Relations between the United States and China and
China’s Role in the Global Economy
John B. Taylor
Under Secretary of Treasury for International Affairs
Committee on Ways and Means
House of Representatives
October 30, 2003
Chairman Thomas, Ranking Member Rangel, Members of the Committee, thank you for giving me the opportunity to testify on economic relations between the United States and China and on China’s role in the global economy.
International Economic Strategy
Our economic relations with China are an important part of our overall economic strategy. The goal of that strategy is to strengthen the current economic recovery and establish conditions that will lead to a long economic expansion in the United States. The economic expansions of the 1980s and the 1990s were the first and second longest peacetime expansions in American history, and with the right policies there is no reason to expect that the current expansion will not be as long or longer. The Jobs and Growth package enacted into law this summer, is an essential part of the policy, as are the President’s proposals for tort reform, regulatory reform, and health care reform.
But even with these policy reforms in the United States there are barriers to economic growth in other countries. And these barriers have ramifications for economic growth in the United States. This is why the international component of our economic strategy is so important.
The strategy has been to urge the removal of rigidities and barriers wherever they exist, and to encourage pro-growth and pro-stability policies that benefit the United States and the whole world. The international strategy is built on bilateral economic relationships, including, of course, our relationship with China. It also has a multilateral foundation, including the meetings of groups such as the G-20, where China is included, or the newly established talks between economic officials from China and the G-7.
Global Economic Recovery
Thanks to the recent fiscal and monetary policy actions, the United States economy is now expanding much more rapidly. Consumer spending is growing at a very strong pace, housing remains solid, and business investment is picking up. The latest data also show exports to be gaining strength compared with the first half of the year. The September employment data showed a promising increase in jobs as well.
Global growth is also improving. There is continuing evidence of stronger economic growth in the Japan, Canada, and the United Kingdom. An increase in business and consumer confidence in the Euro area is a welcome sign that economic recovery is on the way there too. Much of Asia seems to have bounded back from the SARS induced slowdown in the first part of the year. Growth in China recovered sharply in the third quarter following a decline in the second quarter. Growth in other emerging markets is also picking up as the number of crises is down, capital flows are up, and interest rate spreads are low compared with the late 1990s
Pressing Ahead on the Global Economic Expansion
Despite this progress, we need to do more. Last month the G7 launched a new Agenda for Growth. For the first time each G7 country will take part in a process of benchmarking and reporting actions to spur growth and create jobs. Another example is the new United States-Brazil Group for Growth through which we will work together to identify pro-growth strategies at the micro as well as macro levels. Exchange rate policy also has bearing on growth and stability. Earlier today the Treasury issued its latest Report on International Economic and Exchange Rate Policies. This report examines exchange rate policies in major countries around the world. The Report reiterated our view that flexible exchange rates are desirable for large economies. However, the report documents that a number of countries continued to use pegged exchange rates and/or to intervene substantially in the foreign exchange market. The Administration strongly believes that a system of flexible, market-based exchange rates is best for major economies. For this reason, the Bush Administration is aggressively encouraging our major trading partners to adopt policies that promote flexible market-based exchange rates combined with a clear price stability goal and a transparent system for adjusting the policy instruments.
The move by several large emerging market countries—such as Brazil, Korea, and Mexico—to flexible exchange rates combined with clear price stability goals and a transparent system for adjusting the policy instruments is one of the reasons we are seeing fewer crises and greater stability. We emphasize that the choice of an exchange rate regime is one where country ownership is particularly important. We also recognize that, especially in the case of small open economies, there are benefits from a “hard” exchange rate peg, whether dollarizing, as with El Salvador, joining a currency union, as with Greece, or using a credible currency board, as in Bulgaria.
The Economy of China and its Links to the United States and the Global Economy
Let me now address China’s economy. Economic reforms in China have increased economic growth and transformed China into a major economy in the world, both in terms of total production and in terms of purchases and sales of goods with the rest of the world. Yet, 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 global current account surplus was under 3 percent of GDP in 2002 and declined to 1.8 percent in the first half of 2003. Despite the relatively small overall surplus, China has a large trade surplus with the United States. This means, of course, that China has a large deficit with the rest of the world. China’s bilateral trade surplus with the United States was $103 billion in 2002 while China’s trade deficit with the rest of the world was about $73 billion, leaving an overall surplus of $30 billion. Many imports from China are goods from other Asian economies that are processed or finished off in China before shipping to the United States and other countries. 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 in U.S. imports declined to 17 percent from 27 percent over the same period. Thus, the total share of U.S. imports coming from these four Asian countries has remained steady since 1990, actually falling slightly from 30 percent to 29 percent.
U.S. imports from China are about 1 percent of U.S. GDP, or 11 percent of total U.S. imports. U.S. imports from China have been increasing rapidly, between 20 and 25 percent in 2002 and 2003. 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 United States. 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, U.S. merchandise exports to China grew 21 percent in the first 8 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, chemicals, and semiconductors.
The U.S. trade deficit with China should be viewed in the context of the overall trade deficit of the United States. The U.S. trade deficit 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 best understood in terms of the gap between investment and 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. Increased growth abroad is also crucial to increasing U.S. exports.
China’s Exchange Rate Regime
For nearly ten years now, the Chinese have maintained a fixed exchange rate for their currency 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 or the yen, 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 $171 billion to $384 billion (as of end-September).
This accumulation of foreign exchange reserves would tend to expand China’s money supply, although in recent months the Chinese central bank has moved to reign in monetary expansion. Among other measures to sterilize reserve accumulation, the central bank has—for the first time—begun issuing central bank paper to restrict growth of the monetary base. Nevertheless, the broader money supply continues to grow very rapidly: M2 climbed 21 percent over the 12 months ending in September 2003.
It is also important to recognize that China still has significant capital controls. China’s capital controls allow for more inflows than outflows, thus bolstering foreign exchange reserves. China is gradually loosening some controls, and outflows are likely to grow as new channels develop for Chinese to seek diversification and better returns than those offered by low domestic interest rates. Indeed, there is already significant leakage of capital. A relaxation of controls on outflows would reduce upward pressure on the yuan.
Economic Relations between the United States and China
With its rapid growth and substantial foreign exchange reserves, China is now in a position to show leadership on the important global issue of exchange rate flexibility. China represents one of the largest economies in the world, and a flexible exchange rate regime would be a good policy for China. It would allow China to open the nation to capital flows and reduce macroeconomic imbalances. We have been urging China to move to a flexible exchange rate.
We have also urged the Chinese to move forward in two other areas: reductions in barriers to trade and capital flows. In the area of trade, it is important for China to fully implement, and even surpass, the commitments it made to the World Trade Organization. It is important that China continue to open markets to U.S. services, agricultural and industrial products, and to effectively enforce intellectual property laws.
China’s restrictions on capital flows are one of the major rigidities interfering with market forces. The authorities understand this and are beginning to reduce barriers to capital flows and develop more open and sophisticated capital markets. They are also working to strengthen the banking system and liberalize capital flows in order to prepare for a more flexible exchange rate.
Secretary Snow traveled to Beijing last month to urge further progress. He met Premier Wen, Vice Premier Huang, Central Bank Governor Zhou, and Finance Minister Jin. He met again with the Finance Minister and Central Bank Governor last week in Mexico.
President Bush recently met with President Hu. He discussed each of these economic issues. He stressed the importance of reducing barriers to trade, of removing restrictions on the transfer of capital, and of moving to a flexible, market-based, exchange rate. Recently, both Secretary Evans and US Trade Representative Robert Zoellick traveled to China to stress the importance market opening, especially in the area of trade in goods and services. In an important recent development, Vice Premier Huang has accepted an invitation to come to the United States to engage in high-level talks with Secretary Snow.
All of Secretary Snow’s meetings have been detailed and candid. He stated publicly, “the establishment of flexible exchange rates, of a flexible exchange rate regime, would benefit both our nations as well as our regional and global trading partners.” The Chinese reported that they intend to move to a market-based flexible exchange rate as they open the capital account. The central bank governor stated publicly that reform of the exchange rate regime is a central part of their foreign exchange reforms.
Secretary Snow’s visit to Beijing achieved significant progress, including new policy announcements by China’s central bank; liberalized regulations for foreign firms managing their foreign exchange; and significantly liberalized provisions to allow Chinese travelers to take foreign currency out of the country and to do so more frequently. The United States will continue to urge the Chinese to make rapid progress in these areas.
We intend to continue both technical work and high-level talks and on this subject. We have just established a United States-China Technical Cooperation Program in the financial area that will help China develop its financial market infrastructure, including the foreign exchange market.
The Chinese and the G7 agreed to engage in talks about these economic issues. This represents another example of how China, the United States and other affected parties can come together to work on an issue of vital interest to them all. The first meeting between senior officials from the G-7 and China’s finance ministry and central bank took place in September in Dubai, where the Chinese economy, the G7 economies, and other economic issues, were discussed. Further meetings will be scheduled on a regular basis with China, the United States and the other G7 countries. After the Dubai meeting, China’s central bank representative said that China is moving as fast as it can in its reform.
I am pleased to report that our economic strategy is showing progress: global economic growth is accelerating, led by an even stronger acceleration of economic growth in the United States. Our efforts to engage in financial diplomacy are generating constructive responses, though much more needs to be done. Active engagement with China and other countries is paving the way toward freer markets. The Administration’s effort to raise growth in the United States and abroad, and thereby create jobs at home is succeeding.
China’s yuan revaluation a response to increased US pressure
By John Chan
29 July 2005
Last week’s decision by the Chinese central bank to revalue the yuan by 2 percent against the US dollar reflected two sets of pressures operating on the Chinese government.
On the one hand it was aimed at deflecting US demands, especially from the Congress, that China revalue its currency or face retaliatory tariffs. On the other, the small size of the revaluation reflected concerns within Chinese financial circles that too rapid a movement could have adverse consequences for the banking system.
With the small increase having virtually no effect on the US trade deficit with China, the governor of the People’s Bank of China, Zhu Xiaochuan, held out the prospect that the increase was an “initial adjustment”.
The Chinese currency has been pegged to the greenback at 8.28 yuan for a dollar for more than a decade. Now it is set at a rate of 8.11 and will fluctuate against a basket of currencies, including the euro, rather than be set against the dollar alone. The new system is similar to Singapore’s managed “basket, band and crawl” model in which currency floats within a set policy band.
The US and the European powers have been calling for a revaluation on the grounds that the low value of China’s currency, on top of low-cost labour, gives it an unfair advantage in international trade. For their part, China and the other Asian exporters have sought to keep the value of their currencies low by buying up dollar-based assets, thereby financing the US balance of payments deficit now running at close to $700 billion. China’s foreign currency reserves reached $711 billion in June, an increase of 51 percent on the year before.
The revaluation is expected to put on hold moves in the US Congress for the imposition of retaliatory tariffs. Last April, 67 senators passed a resolution, sponsored by Charles Schumer and Lindsey Graham, declaring that if China failed to revalue it currency within six months a 27.5 percent tariff would be imposed on all Chinese imports.
The resolution led to increased pressure on Chinese authorities from US Treasury Secretary John Snow who has been pressing for a revaluation for the past two years. At the G-7 finance ministers meeting in Washington last April Snow warned the Chinese that US patience was running out. In May, Snow persuaded Congress not to brand China “a currency manipulator” but again warned Beijing to expect serious political consequences.
To placate the Congress, Snow organised a meeting between Schumer and Graham with Federal Reserve Board chairman Alan Greenspan. Greenspan has opposed protectionist measures on the grounds that this could upset global financial mechanisms and jeopardise the funding of US deficits. Schumer, however, accused the Bush administration’s position on the yuan as having the “strength of a wet noodle”.
According to reports in both the Financial Times and Wall Street Journal, Snow, who had indicated that a revaluation would come before Chinese President Hu Jintoa’s visit to the US in September, was told a week in advance of the new exchange rate regime. The Financial Times reported that he had assured Beijing that the US would warmly welcome the move and that there would be broad international support.
But whether the currency regime change is enough to placate protectionist moves in the Congress remains to be seen. So far the revaluation is well short of the currency shift of up to 40 percent being demanded by some of Beijing’s critics and the 10 percent increase that former secretary of state Henry Kissinger has told Chinese authorities will be needed to stave off protectionist legislation.
Schumer said the Chinese action was a positive first step but he hoped for more. “We are going to watch and see what happens over the next few months,” he said. The president of the National Association of Manufacturers, John Engler, who has headed the push for revaluation, said he hoped by October “to see that China’s currency has moved significantly enough to begin correcting long-standing trade distortions.”
Jia Qingguao, a US specialist in Peking University, told the New York Times that the revaluation of the yuan was part of Beijing’s efforts for a calmer relationship with Washington. “My feeling is that the leadership would really like to take the politics out of the relations and return to a more pragmatic atmosphere. I don’t expect that this one step will resolve the tension completely. But I think once the first step is taken, it will be easier to make currency adjustments later on,” Jia said.
But even if such measures are taken, they will make little difference to the trade problems of the US. As the Financial Times commented on July 25: “China mainly assembles imported parts and components manufactured elsewhere. The local value-added in its exports is as low as 15 percent. Any loss of competitiveness from a stronger exchange rate would be largely offset by cheaper imports. Even a 25 percent revaluation would raise prices of many Chinese exports by only about 4 percent.”
In other words revaluation, even by a significant amount will do little to shift the imbalances in the global economy, and remove the threat of a rapid loss of confidence in the US dollar. Significantly, the former chairman of the Federal Reserve Board, Paul Volcker, has repeated his warning of last February that “the circumstances seem to be as dangerous and intractable as any I can remember.”
“If people lose confidence in the dollar as a store of value, or lose confidence in the political strength of the US relative to other countries, there is going to be trouble. I’m not saying a crisis is inevitable or that orderly adjustment is impossible, but at some point big adjustments will have to be made,” he told the New York Times.
In a comment published in the Financial Times last Wednesday Nobel laureate economist Joseph Stiglitz pointed out that America’s trade deficit of $700 billion is nine times China’s trade surplus and that “even larger revaluations are not likely to do much to the global imbalances.”
The major problem for US exporters is not the value of the Chinese currency but the lack of significant economic growth in major markets such as the EU and Japan. In Asia, the pervasive poverty has prevented any significant expansion of internal consumption. China, in particular, has very high savings rates of 40 percent of gross domestic product or 25 percent of household income.
Moreover, the competition from Asia comes from US and European firms, which have sought to counter falling profit rates by moving their operations to cheap-labour regions. In other words, the rise of China, and Asia as a whole, as a cheap labour platform, is not the cause, but rather the result, of deepening contradictions within the world capitalist economy.
Beijing has been walking on a fine line in dealing with US and European pressure on the yuan. The integration of China into the world capitalist market in the 1990s has produced huge unemployment, poverty and increased social tension.
Although China’s energy industries such as oil and electricity, which are increasingly depend on import or foreign loans, will benefit from a higher value of yuan, the engine of the economy—the export sector—could suffer.
The Shanghai-based International Finance News warned that large corporations may be able to absorb the 2 percent appreciation but small businesses, dependent on tiny profit margins, could face serious troubles. It is estimated that for each 1 percent rise in the yuan, each sub-sector of the textile industry will see its profits from exports reduced, including a drop of 12 percent in cotton sector, 8 percent in wool, and 13 percent in garments. Smaller segments of the garment industry that depend more highly on exports will face even higher losses.
“Uncompetitive small-and-medium-sized companies would then likely face bankruptcy, causing possible job losses for several hundred thousands workers. Since most of the employees in the textile industry come from low or medium income families, the loss of jobs could possibly trigger even greater social problems,” the Chinese paper noted.
Chinese analysts and economists have also warned that the pressure of foreign and domestic speculators could trigger a collapse of China’s real estate bubble. Since the US and other powers openly began advocating a yuan revaluation in 2003, tens of billions of dollars of “hot money” have flooded into China to buy yuan-based property.
In Shanghai, half of the property market is estimated to be inflated by speculative funds and in total, over 60 percent of capital in purchasing homes or new construction is lent from China’s debt-stricken banking system. More speculators are expected to move in to bet on a further appreciation of yuan.
Despite the so-called “cool-down” policy introduced last year, newly released official data shows that the investment bubble, especially in real estate, continues. China’s fixed asset investment rose 25.4 percent on a year-on-year basis to $US353.7 billion during the first half of the year.
Financial authorities in China are now engaged in a delicate balancing act. While they want to give the impression that there is greater flexibility in the Chinese currency in order to fend off demands from the US for a rapid revaluation, they also want to maintain capital and currency controls in order to prevent violent shifts of investment funds and speculative capital. If there is an expectation that the value of the yuan will rise further, then “hot money” will continue to move in. However, Chinese authorities, having witnessed the consequences of the Asian financial crisis of 1997-98, are also fearful of the consequences of an outflow.
It is a measure of the fragility of the global financial system, in which no national government has control over vast market forces, that economic management has become a kind of guessing game.
Reuters reports that presidential candidate Barack Obama is saying China’s trillion dollar surplus is “directly related to its manipulation of its currency’s value” in a letter written to the U.S. National Council of Textile Organizations published Wednesday. This statement directly contradicts the Bush Administration, which has refused to label China as a “currency manipulator”.
Obama calls for China to change its current policies to rely less on exports and more on domestic growth, saying he “will use all diplomatic means at my disposal to induce China to make these changes.”
The exchange rate of the yuan to the US dollar is a hot issue, because many believe Beijing purposely undervalue the currency to boost exports and discourage imports. While the Bush Administration has successfully pressured China for years to increase the value of the yuan, it refused calling China a “currency manipulator” because of possible World Trade Organization repercussions.
Republican presidential candidate John McCain had not responded to the questionnaire sent on October 1st to both candidates.
In 2007, the U.S. trade deficit with China reached $256.2 billion, including U.S. imports of more than $30 billion in clothing and textiles. Textile producers in the U.S have pressured the Bush administration for a program to guard against an “import surge” when current quotas end.
China responded to the comments by saying the “exchange rate is not the cause of the trade deficit” but did not give further comment.
Foreign Ministry spokeswoman Jiang Yu said the yuan exchange rate is not the case of the U.S trade deficit and that she, “hope(s) that the U.S. can expand its exports to China and reduce barriers for trade and investment. We believe this will help the U.S. reduce its trade deficit.”
Obama claims that the result of this “currency manipulation” is “a large imbalance that is not good for the United States, not good for the global economy and likely to create problems in China itself.”
Jiang did not give any comment on who China would favor in the upcoming presidential election.
Meanwhile, in the Economist’s recent article, China moves to centre stage, claims that China is “in no rush to act”.
While China is enjoying the attention it’s trillion dollar reserves garner, it is “resisting the tempation to swagger in its dealings with American.”
A Chinese newspaper made claims recently that America should give up its control over the International Monetary Fund (IMF) in return for China helping the current crisis. The government has not made that claim, however, China would like to see an end to the American de facto veto power in the IMF. Currently, the IMF has a report “examining whether China has been manipulating its exchange rate for the sake of trade advantage.”
“There’s no safer investment in the world than in the United States,” White House Press Secretary Robert Gibbs said yesterday at a briefing in Washington.
Gibbs was responding to comments from Wen that China, the U.S. government’s largest creditor, is “worried” about its holdings of Treasuries and wants assurances that the investment is safe. “I request the U.S. to maintain its good credit, to honor its promises and to guarantee the safety of China’s assets,” Wen said at a press briefing in Beijing.
President Barack Obama is relying on China to sustain buying of Treasuries amid record amounts of U.S. debt sales to fund a $787 billion stimulus package and a deficit this year forecast to reach $1.5 trillion. Investors abroad own almost half of all U.S. debt outstanding, and China last year overtook Japan as the biggest foreign buyer.
Wen’s comments contributed to a decline in Treasuries yesterday. Yields on benchmark 10-year notes rose as high as 2.96 percent, from 2.85 percent a day earlier, and closed at 2.89 percent.
U.S. President Obama has also responded to China’s worries. From Reuters:
Obama also sought to reassure China, which expressed concern on Friday that massive U.S. deficit spending and near-zero interest rates would erode the value of China’s huge U.S. bond holdings.
“There is a reason why even in the midst of this economic crisis, you’ve seen actual increases in investment flows here in United States,” he said. “I think it’s a recognition that the stability not only of our economic system but also our political system is extraordinary.”
“Not just the Chinese government but every investor can have absolute confidence in the soundness of investments in the United States.”