Introduction
China Currency Trade Bill is a law that was approved by the United States Senate in September 2011. It is a law that proposes an addition of tariffs to nations, with China as the most notable, established to be devaluing their currency. The bill's main intention is to make expensive the imports from these nations, equalling the trade discrepancy and declining the nation’s imbalanced economic gain. The bill is contentious bill since China holds a huge economic impact, being top U.S. trading associates, and grips a huge U.S. debt.
Imports and exports in totality will actually fall from 2013 onwards, but there will be large negative effects on imports from China as noted before while there will be positive effects on imports from other countries such as Japan, Indonesia and Taiwan. The positive effect on the current account deficit over baseline will therefore small since the overall savings investment balance changes little in the United States or the rest of the world. Note that the actions of the US was to cause a real effective depreciation of the Chinese currency, not the real appreciation they are seeking! By not buying goods from China, Chinese export prices fall on world markets and they are more competitive on other market; a real effective depreciation.
Now in any case China retaliates, it will probably do so by imposing some tariff on goods from the USA at the same time that there will be the imposition of the US tariff. In this case, there will be a large drop in total China’s imports although there will be a significant switching from imports from the United States to other sources. Higher cost imports will cause inflation to augment in China so the combined effect of the US tariff on imports and China’s retaliation will be a smaller reduction in inflation than before.
The smaller drop in inflation in China means there is a smaller real effective depreciation of the exchange rate. The effect of the retaliation to the United States is assumedly to cause a smaller overall real appreciation of the US currency so the monetary response by China’s authorities to maintain the currency peg will be moderated. The effect on China’s real investment will therefore be moderated in 2013 than when the US imposes a tariff on China’s exports to the US alone. The same is true for real GDP (Wayne, 2003).
The retaliation by China will as well cause the US total exports to fall, but the effect will not be great since China is not a significant destination for US goods. The decline in US real GDP and real consumption will be greater. Real GDP could be more than 0.05 per cent lower than baseline for several years from 2013 onwards. The overall message is that retaliation by China moderates some of the effects of the US tariff on Chinese imports and it imposes marginally greater costs on the United States. The retaliation does little to change the US current account deficit or the overall trade balance of the United States, which in any case showed small effects from tariff changes
When China revalues its currency, its goods become more expensive in world markets, Exports fall as a result below baseline in 2012. Since exports have fallen, so has aggregate demand and so there is a drop in inflation. Real short-term interest rates (nominal rates adjusted for expected inflation) rise above base in 2012 as a result of the appreciation. The higher real interest rates depress investment, real consumption and therefore real GDP. China’s real GDP could be over 10 per cent below baseline in 2012 and nearly 4 per cent below in 2013. Given that baseline growth of real GDP in China say 9 per cent, the currency appreciation of the magnitude implied by the introduced United States legislation would put China into recession. Little wonder that China is resisting any large appreciation of the currency quite apart from any financial stability aspects.
The fall in imports may seem surprising given the large appreciation of the currency and hence fall in import prices. Chinese consumers should shift away from local goods to imported goods. They do, but note there are two effects operating here. One is the price effect just described that boosts imports. The other is an income effect. Falling output and incomes means total consumption falls and this reduces the consumption of imports (as well as local goods). It happens that the negative income effect outweighs the positive price effect so overall imports initially decline by below baseline in 2012 before gradually recovering as the economy recovers.
With both imports and exports declining when China revalues its currency there is little change in the trade balance or the current account balance. If there is little change for net capital flows there can be little change on current accounts of other countries. In fact there is little change to the current account deficit of the United States. To reiterate what was emphasised in the last report on the US current account deficit, the proximate cause of the deficit is the savings and investment imbalances around the world — not China’s exchange rate regime.
Imposing a tariff on Chinese imports into the United States to force a revaluation is a counterproductive idea. It does nothing for the United States’ overall economic performance except worsen it marginally and provides little change to the current account deficit. The policy is unlikely to cause China to revalue its currency. It could even stiffen China’s resistance to a revaluation and lead to retaliation. Even if China did revalue there is no significant effect on the United States due to offsetting price and income factors. One caveat is that we have not assumed any change by China in their huge holdings of US Treasuries; a change that would have repercussions for US bond prices and interest rates.
That a revaluation has little impact on the United States imbalances does not mean that China should not revalue its currency since it would give them far greater control over the management of their domestic economy (Marc , 2002). It would take the heat out of the Chinese economy and avoid the use of other less efficient methods to cool their economy. It would, for example, give China an alternative to managing a looming housing price bubble.
An earlier report on China’s possible revaluation goes into the pros and cons of a currency change. Note too, that in going from deflation a few years ago to inflation now above that of trading partners, China’s real effective exchange, which is what matters, is already appreciating.
Trade tensions and pressures on the Chinese government to appreciate their currency are not productive avenues to solving the global imbalances that are emerging. A report showed that the single biggest step the United States could take to remove some of the global imbalances that have emerged is to rein in their large and growing fiscal deficit and to raise their domestic private savings rate.
References
Marc, L. (2002) Macroeconomic Policy new york: Marc publishers
Wayne M. M,(2003) Asian Trade and Finance Calcutta: Morrison publishers
