ECN 5050- SPRING 2013

Maria Baquerizo Fadwa Talaoui Rida Bouchoutrouch Manuel Lemus

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 Price of a Big Mac in China Average Price of a Big Mac in 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 the United States was 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 an ideal 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 spending is still showing confidence. Third is manufacturing, especially from agri-business that added inventory.

 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 of U.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 of debt held by the public. China buys U.S. debt to support the value of the dollar. China pegs its currency (the Yuan) lower than the U.S. dollar to 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 saying they did raise the Yuan's value by 20% between 2005-2010.

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 deficit with 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 the declining dollar,, which makes exports cheaper when compared to foreign goods and services. However, a more important shift has been the inactivity of U.S. consumer demand for imports combined with a 10% growth in Chinese consumer demand.

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. This would be an unacceptably high burden for 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 Chinese purchases. For borrowers, this is good; for lenders, not so good.

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/2013/01/29/readi

ng-the-tea-leaves-on-u-s-china-economic-relations/
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/what_is_ currency_manipulation/index.htm http://www.davemanuel.com/investordictionary/currency-devaluation/ http://www.investopedia.com/terms/e/exchangerate.asp http://www.investopedia.com/terms/forex/f/foreignexchange-markets.asp http://en.wikipedia.org/wiki/Currency_war