Even if China does revalue its currency, jobs aren’t likely to come flooding back to the United States. Much of what China exports to the U.S. originates in other Asian countries.Foreign exchange rates ; International finance ; China

Brett W. Fawley

Luciana Juvenal

English

Research Papers in Economics

Why “Fixing” China’s  
Currency Is No Quick Fix
By Brett Fawley and Luciana Juvenal
O
n net, the U.S. economy added zero 
jobs over the past decade:  Eight 
million jobs gained from 2003-07 were 
countered with eight million jobs lost from 
2008-09.  The recent recession, despite its 
severity, cannot shoulder all blame for this 
outcome.  Average job growth during the 
2003-07 expansion was 60 percent slower 
than average job growth over previous eco-
nomic expansions following World War II. 
The sluggish growth was likely driven by 
a combination of internal factors (increased 
productivity) and external factors (job 
outsourcing and large sustained trade 
imbalances).  For example, Figure 1 shows 
that from 1994 to 2006 the U.S. multilat-
eral trade deficit in goods grew from 2.5 to 
6.5 percent of GDP.  To the extent that this 
trend reflects diminished U.S. competitive-
ness in international goods markets, some 
U.S. manufacturing jobs may have been lost 
to foreign competitors. 
Meanwhile, the U.S. Treasury is threaten-
ing to label China as a “currency manipula-
tor” for allegedly using foreign exchange 
intervention and currency controls to fix 
the value of its currency (the renminbi) to 
the dollar in order to prevent appreciation 
of its currency and to gain a trade advantage 
through lower international prices for its 
exports.  As revealed in Figure 1, the U.S. 
bilateral trade deficit with China accounts 
for a nontrivial (and growing) share of the 
U.S. total trade deficit.  Does this mean that 
an increase in the value of the renminbi 
would reverse declines in U.S. trade compet-
itiveness due to biased terms of trade and, 
in turn, create jobs in the United States?  
Unfortunately, the answer is “probably not 
to any meaningful degree.” 
It’s Not Just U.S. vs. China
Assuming that the renminbi is underval-
ued,
1 any effect its revaluation would have 
on U.S. labor markets depends entirely on its 
impact on the U.S. multilateral trade deficit 
with all countries, not on the bilateral trade 
deficit with China taken in isolation.  Smaller 
U.S. trade deficits with China, offset by larger 
bilateral deficits with other countries, cannot 
be expected to provide material job growth.
A renminbi revaluation is unlikely to 
seriously impact the multilateral trade 
deficit for two reasons.  First, multilateral 
trade balances are in part determined by 
domestic preferences that may not hinge on 
the exchange rate.  For example, a country 
importing more than it exports must fund 
this spending with inflows of foreign capital.   
The magnitude of capital inflows is primarily 
determined by the gap between gross domes-
tic investment and gross domestic savings.  
Revaluing the renminbi is unlikely to fun-
damentally shift U.S. domestic preferences 
for saving and investment.  Second, regional 
specialization patterns in Asia suggest that a 
major component of the U.S. bilateral trade 
deficit with China is a persistent trade deficit 
with Asia.  The price, and hence quantity, of 
Chinese exports may be surprisingly resilient 
to changes in the value of the renminbi.
In 2003, tension was equally high with 
respect to China’s dollar peg, and the U.S. 
Congress was also considering retaliatory 
measures.  The Congressional Budget Office 
(CBO), however, concluded that a revalua-
tion of the renminbi would have little effect 
on U.S. manufacturing employment.  In 
particular, China, owing to cheap labor 
costs, functioned primarily as a place of 
assembly for the Asian region.  Intermediate  
goods were exported to China from other 
Asian countries; these goods were then 
assembled and exported to the United 
States.  As evidence of this emerging 
specialization pattern, the CBO reported 
that from 2000-2002 a large portion of the 
increase in imports from China was offset 
by declining imports from Japan.  Among 
developing Asian countries (outside of 
China), nearly all showed declining exports 
to the United States during this period. 
Accurately estimating the size of this 
regional trade effect over a longer period of 
time is essential for U.S. trade policy, but 
such estimation is not without obstacles.  In 
particular, the CBO analysis benefited from 
looking at a period of U.S. recession.  Dur-
ing times of economic expansion, imports 
from nearly all trading partners increase, 
making it hard to distinguish between the 
effects of increasing globalization and the 
potential redirection of exports within  
trading partners. 
To help disentangle the two effects, 
consider what bilateral exports would be 
had countries’ export growth been evenly 
distributed across all trading partners.  
Specifically, we compute for 174 countries 
what exports to the United States and China 
would have been in 2007 had each shipped 
the same fraction of its total exports to the 
United States and China as it did in 1994.  
We then compare this hypothetical number 
to actual exports and plot the differences 
in Figure 2.  Interestingly, the countries 
that stick out with the largest unpredicted 
increases in exports to China (and corre-
spondingly largest unpredicted decreases 
in exports to the United States) are, in fact, 
the Asian countries implicated by the CBO 
as moving their assembly to China.  This 
is in stark contrast to the high density of 
© ImagInechIna/corbIs
t r a d e
4   The Regional Economist  |  April 2011points centered at zero-zero, revealing that 
most countries’ trade shares with the United 
States and China remained roughly con-
stant.  Incidentally, a simple linear regres-
sion reveals that the relationship between 
greater-than-predicted exports to China and 
less-than-predicted exports to the United 
States is strongly statistically significant. 
To the extent that Chinese exports to 
the United States originate beyond China’s 
borders, such trade flows are generally insen-
sitive to the value of the renminbi:  Most 
of the value of the goods is added in other 
countries and denominated in other cur-
rencies.  Specifically, the 2003 CBO report 
cites estimates that only 20-30 percent of the 
total value added of Chinese exports occurs 
in China.  Hence, only 20-30 percent of the 
value of Chinese exports is subject to the 
effects of a renminbi revaluation.  The dollar 
value of the remaining 70-80 percent of the 
goods would remain unaffected.  Chinese 
manufacturers could import intermediate 
inputs for less money following a renminbi 
revaluation and pass the cost savings directly 
through to the final price, largely offsetting 
any increase in the price due to the higher 
value of the renminbi.  Such results confirm 
that persistent global trade imbalances will 
require multilateral solutions. 
Revaluation May Be Inevitable
China will probably have to revalue its 
currency in the near future even without  
the threat of U.S. retaliation.  The true  
relative purchasing power of two countries 
is determined not by the nominal exchange 
rate (the price of one currency in terms 
of another as reported on a currency 
exchange), but by the real exchange rate, 
which takes into account relative changes 
in domestic price levels.  When China sells 
renminbi for U.S. dollars in order to affect 
the exchange rate, it adds currency to its 
domestic money supply.  All else equal, 
the increase in the currency base increases 
domestic prices, canceling out any change 
in the real exchange rate due to nominal 
depreciation of the renminbi.
2  Countries 
can absorb some of the additional liquidity 
through “sterilization,” i.e., buying back 
the currency by selling bonds, but only to a 
point.  The dependence between monetary 
and foreign exchange policy will ultimately 
force China’s hand, but the United States  
cannot expect any quick labor market 
fixes due to Chinese currency revaluation.  
Instead, the United States would be best 
advised to follow China’s suit in identify- 
ing and exploiting its own comparative 
advantages. 
Luciana Juvenal is an economist and Brett 
Fawley is a research associate, both at the 
Federal Reserve Bank of St. Louis.  See http://
research.stlouisfed.org/econ/juvenal/ for more 
on Juvenal’s work.
E N DNO T E S
  1  Consensus estimates are that the renminbi 
is undervalued by 25-40 percent, but there 
are reasons (like a still developing Chinese 
banking sector) why even if allowed to float, 
the renminbi could depreciate, rather than 
appreciate.
  2  If the renminbi loses half of its value against 
the dollar, but domestic prices in China dou-
ble, the cost of a Chinese good, in U.S. dollars, 
remains the same.  No effect on trade would 
be expected from the nominal depreciation.
R E F E R E NC E
Holtz-Eakin, Douglas.  “The Chinese Exchange 
Rate and U.S. Manufacturing Employment.”  
Congressional Budget Office testimony before 
the Committee on Ways and Means, U.S. 
House of Representatives, October 2003. 
FIGURE 2
Asian Exports Have Shifted Toward China, Away from U.S. 
FIGURE 1
U.S. Balance of Trade in Goods
1994 1996 1998 2000 2002 2004 2006 2008
0
–1
–2
–3
–4
–5
–6
–7
De￿cit with China
Remaining De￿cit
%
 
O
F
 
G
D
P
18% 20% 22% 25% 23% 21% 19% 20% 22% 23% 25% 26% 28% 32% 33% 44%
soUrce: ImF Direction of Trade statistics (DoTs) and bureau of economic analysis.
soUrce: ImF Direction of Trade statistics (DoTs) and authors’ calculations. 
noTe: This figure compares reported 2007 bilateral exports to the United states and china with what they would have 
been had countries maintained their 1994 export shares with each trading partner.  asian countries stand out as 
increasing their share of exports to china while decreasing their shares of exports to the United states.  one plausible 
explanation is that these countries moved final assembly of their domestically produced intermediate goods to china.
–10 0 10 20 30 40 50 60 70 80
10
0
–10
–20
–30
–40
–50
–60
–70
Japan
Korea Hong Kong
Singapore
Thailand
Malaysia
Philippines
2007 EXPORTS TO CHINA LESS VALUE PREDICTED BY 1994 SHARE OF EXPORTS TO CHINA (BIL. $)
2
0
0
7
 
E
X
P
O
R
T
S
 
T
O
 
U
.
S
.
 
L
E
S
S
 
V
A
L
U
E
 
P
R
E
D
I
C
T
E
D
 
B
Y
 
1
9
9
4
 
S
H
A
R
E
 
O
F
 
E
X
P
O
R
T
S
 
T
O
 
U
.
S
.
 
(
B
I
L
.
 
$
)
The Regional Economist  |  www.stlouisfed.org   5

Why "fixing" China's currency is no quick fix

http://www.stlouisfed.org/publications/pub_assets/pdf/re/2011/b/china.pdf

Why "fixing" China's currency is no quick fix

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics