Impact of Chinas Foreign

Exchange Rate Upon U.S

Economy
ECN 5050- SPRING 2013

Outline
Introduction
Relationship Between US and

Chinas Economy
The Effect of Chinas
Devaluated Currency on US
Economy
Conclusion

Introduction

What is a currency devaluation?

Currency devaluation is a condition in

international affairs where countries compete

against each other to achieve a relatively low
exchange rate for their own currency.
As the price to buy a particular currency falls so
too does the real price of exports from the
country.
Imports become more expensive, which can harm

citizens' purchasing power.

Domestic industry and employment receive a
boost from both domestic and foreign markets.

Definition of the Exchange Rate

The price of one country's currency expressed in

another country's currency. In other words, the

rate at which one currency can be exchanged for
another.

Illustration
An interbank exchange rate of 91 Japanese yen

(JPY, ) to the United States dollar (US$) means that

91 will be exchanged for each US$1 or that US$1
will be exchanged for each 91. Exchange rates are
determined in the foreign exchange market

Definition of the Foreign Exchange

Market
The market in which participants are able to buy,

sell, exchange and speculate on currencies.

For example, a typical foreign exchange

transaction will involve a party purchasing some

quantity of one currency by paying some quantity
of another currency.

The big players in the foreign exchange market

are banks, large commercial entities hedge fund,

investment firms and nations central banks.

What is a currency
devaluation?
A currency devaluation occurs when a country

allows the value of its currency to drop in relation

to other currencies.

If a currency value drops, then:

Exports will become less expensive
Imports will become more expensive to people living in
the country
Decreases the trade deficit.
By selling its own currency and buying up foreign

reserves like the U.S. dollar, China has essentially

pegged the Yuan's value to the dollar instead of
allowing it to move freely in foreign exchange markets.

What's so great about a cheaper

currency?
A weak currency cheapens the price of a

country's exports, making them more attractive

to international buyers by undercutting
competitors.
It boosts the domestic economy since the country

relies more on its production to satisfy its needs.

China's economy is primarily export-driven, so

having a leg up on the international competition

has allowed its economy to grow at high speed.

What's wrong with that?

Several industrialized nations, including the U.S.,

think China's explosive growth is unsustainable, and

bad for the global economy. They fear its rapid
inflation could ripple through the rest of the world,
driving up the price on goods at a time when other
economies are still struggling to get back on their
feet.
Rapid growth has also led to fears that China's

economy could overheat, and then crash land into a

massive slowdown, hindering the world recovery.

Is the Yuan Undervalued?

The IMF as well as some academic studies support that the

Yuan is being undervalued between 30 and 50%.

There are strong opinions that claims that the Chinese

currency is undervalued. Some measurements that support

such claims are the popular "Big Mac Index
The Big Mac Index, measures the prices of a Big Mac burger
in McDonalds around the world adjusted for exchange rates.
A Big Mac in China in July 2012 costs an equivalent of only
$2.45. The average price in the United States is $4.33. This
implies that the Chinese Yuan is undervalued by a little over
40% based on purchasing power parity.

The Big Mac Index, measures the prices of a

Big Mac burger in McDonalds around the
world adjusted for exchange rates
Average
Average
Price
Price of
of a
a Big
Big
Mac
Mac in
in China
China

Average
Average
Price
Price of
of a
a Big
Big
Mac
Mac in
in USA
USA

This implies that the

Chinese Yuan is
undervalued by a
little over 40% based
on purchasing power
parity.

Relationship Between
US and Chinas
Economy

Trade and Financial

Dependence between the
Two Economies
The U.S. is one of Chinas major export

markets.
The Chinese exports to the U.S. rose from
$100 billion in 2000 to $296 billion in
2009, while imports rose from $16 billion
to $70 billion.
The Rising volumes of trade between the
two economies have made them more
important as mutual trading partners

As you we can see from

figure 1
from 1998 to 2006 exports to the U.S. accounted for a relatively stable

share of about 21 percent of Chinas overall export

Starting from 2007 to 2009, the share of Chinas exports going to the
U.S. fell to about 18 percent and The share of U.S. exports going to
China has risen gradually over the years but is still under 5 percent .
Moving to the second graph which is about U.S imports Vs chins
imports we can say that

As a source of U.S. imports, Chinas share has increased

steadily, to 15 percent of total U.S. imports by 2009.

Chinas dependence on U.S. imports, by contrast, has
fallen over time, with imports from the U.S. accounting for
about 7 percent of Chinas imports since the mid-2000s .

From the graphs we can clearly deduce that china

is gaining a lot from this business

relationship compared to U.s
If we want to predict the the nature of this
relationship over the next few decades based on
trends between 1978 and 2006, expectations
would be quite positive.
However, it appears to be no longer the case

In 2009, as theUnited Stateswas crawling out of

recession. at very low rates of growth, experiencing

high unemployment, heavily indebted, and stricken
by uncertainty about the future.
Opinion leaders observed Chinas continued neardouble digit annual economic growth rates.
This was a turning point where the U.s leaders

started asking where did we go wrong ??? And what

china get right ?
The answers that most resonated were that the

United States had been too permissive of Chinas rise

and that it was time for a tougher policy tack, and
that the secrets of Chinas success were five-year
plans and other elements of state-directed capitalism

The United States was portrayed as losing at

trade and it was losing because China

perpetually cheats.
Currency manipulation, subsidization of

industry, dumping, intellectual property

theft, discrimination against imports, forced
technology transfer, indigenous innovation
policies, raw material export restrictions, and
other allegations of cheating came to define
Chinese trade practices.
Some of the reactions that Obama
administrtions were that

By 2011, the Obama administration was

advising U.S. telecom carriers that if they had

aspirations to partake on the lucrative U.S.
government procurement market, they should
not purchase routers or other equipment from
Chinese companies, Huawei and ZTE, citing
them as cyber security threats to the United
States.
In 2012, the House Intelligence Committee
produced a report reaching similar findings and
advising all U.S. companies against doing
business with those companies.
the administration reported progress toward
completion of a trade agreement between the
United States and 10 other Asia-Pacific nations,
which conspicuously excludes China.

The Effect of Chinas

Devaluated Currency on
US Economy

US Economy Right Now

In 2013 the economy grew 2.4%, instead of

the Advance Estimate of 2.5%, from January

through March this year.This is still anideal
growth rate, which is anywhere between two
to three percent.
The US three major sources of economic

growth this year are: First and foremost,

housing construction is solidly expanding in
response to rising housing prices and
demand, which is something we have not
seen in 7 years. Second,consumer

What is the US deficit with

china?
In 2012 the U.S trade deficit with China
was about $315 billion. An increment
of $20 billion from the year before.
The trade deficit exists despite the fact
that U.S exports to china were the
highest in history. In 2012 the US
exported $110 billion in goods.
However imports from china to the US
also set record of $426 billion.

Why there is a U.S trade deficit with

china?
China is able to produce good at a
lower cost because:

Lower standard of living, which allows

companies to pay lower wages to
workers.

They set the exchange rate lower so

that it is always priced lower than the

dollar.

How it affects the US?

American companies cannot compete

with Chinese companies so as a result

jobs are lost.
The US competitiveness in the global

market declines.
China may gain political leverage over

U.S fiscal policy, since it could call in its

loan.

What is being done by the U.S?

In 2009 the US treasury started a dialogue with

China which pressured them to loosen its peg

against the dollar and rose the price of Chinese
exports, lowering the trade deficit.
For example:
Elimination of a 17% tax rebate for exporters.
An increase in central bank interest rates,
increasing the value of the Yuan.
An increase in the reserve requirement for central
banks to 12%.
A $3 billion investment in the U.S. Blackstone Group

China the biggest banker of

the US
China is the largest foreign holder ofU.S.
Treasury bills, bonds and notes. As of January
2013, China owned $1.264 trillion Treasuries.
This is 11% of the total $11.6 trillion ofdebt
held by the public.
China buys U.S. debt to support thevalue of the
dollar. Chinapegsits currency (theYuan) lower
than theU.S. dollarto keep its export prices
competitive
China's role as America's largest banker gives it
leverage. For example, China threatens to sell
part of its holdings whenever the U.S. pressures
it to raise the Yuan's value. China counters by

US exports
In the last 12 months, U.S. exports have grown

23%, outpacing China's export growth rate of

17%.
U.S. export growth is finally beginning to put a
dent in the U.S.trade deficitwith China. In the
first six months of this year, U.S. exports to China
were 20% higher than the same time period last
year, while imports from China were only up 4%. If
this U.S. export to China continues to increase, it
would reverse a 10-year trend.
This is happening as a result of thedeclining
dollar,, which makes exports cheaper when
compared to foreign goods and services. However,
a more important shift has been the inactivity of

How Chinese Exchange Rate

Directly Affects You
The weak Yuan/strong US dollar combination makes

Made in China products on American shelves less

expensive. If the Chinese government allows the
Yuan to increase by 10%, that will mean a direct
increase in the costs of everyday products.
Thiswould be an unacceptably high burdenfor
millions of low and middle-class Americans, as well as
millions of American companies who buy cheap
Chinese imports.
Because of the trade imbalance, the Chinese buy U.S.
Treasury Bills with their excess dollars. This huge
purchasing activity keeps the demand for Treasury
Bills high, which keeps the price high, which keeps
interest rates low. Thus interest rates are perhaps
lower than they would otherwise be without the

Conclusion

China is under valuating its currency by

investing in U.S currency.

U.S knows that Chinas economy is doing well

and this is a long-term threat.

U.S companies really need Chinas business

because of their low wages. US companies

make money out of Chinas low prices.
U.S and China are economically connected

because they both benefit from each other.

References
Amadeo, K. (n.d.). Retrieved from

http://useconomy.about.com/od/tradepolicy/p/uschina-trade.htm
Neil Irwin (n.d) Retrieve from
http://www.washingtonpost.com/blogs/wonkblog/wp/
2013/04/26/the-incredible-stagnant-u-s-economy/
NELSON D. SCHWARTZ (n.d) Retrieve from
http://www.nytimes.com/2013/05/04/business/econom
y/us-adds-165000-jobs-in-april.html?pagewanted=all

References
http://www.brookings.edu/research/testimony/2010/

02/25-us-china-debt-prasad
http://www.forbes.com/sites/danikenson/2013/01/2

9/reading-the-tea-leaves-on-u-s-china-economicrelations/
http://www.bbc.co.uk/news/business-20177210
http://www.bankrate.com/finance/economics/chinas

-economy-influences-us-1.aspx

References
http://www.nasdaq.com/article/what-does-chinas-

currency-manipulation-mean-for-the-dollar-cm182405
http://money.cnn.com/2010/11/10/news/economy/wh
at_is_currency_manipulation/index.htm
http://www.davemanuel.com/investordictionary/currency-devaluation/
http://www.investopedia.com/terms/e/exchangerate.a
sp
http://www.investopedia.com/terms/forex/f/foreignexchange-markets.asp
http://en.wikipedia.org/wiki/Currency_war