U.S. Yuan Debate Ignores Economic Realities, China’s Currency Reforms

U.S. Yuan Debate Ignores Economic Realities, China’s Currency Reforms

The Currency Exchange Rate Oversight Reform Act, approved in the U.S. Senate last week by a majority of 63 to 35, risks damaging U.S.-China relations and further eroding Washington's economic standing in the international community, and all for very little reward. The bill calls for retaliatory trade measures against countries that maintain an undervalued currency, and while it does not mention China by name, the United States' largest trading partner is clearly its main target. The Chinese yuan is without doubt undervalued, but this is only one of a number of factors contributing to the U.S. trade deficit. Moreover, at a time when U.S. economic credibility is at an all-time low, the bill ignores tangible measures China is taking to develop its currency regime and distracts from the need for a more introspective and pertinent discussion of America’s economic challenges.

On a purchasing power parity basis, the yuan may be undervalued by up to 30 percent against the dollar. This has been a key source of competitive advantage for China over the past two decades and is one of many ways in which Beijing insulates domestic enterprises from market forces. However, since China depegged its currency from the dollar in 2005, the yuan has appreciated by more than 30 percent. If respective interest rates are taken into account, appreciation in the year to date has been more than 10 percent.

Moreover, along with significant appreciation, the past 12 months have seen Beijing engage in an unprecedented series of moves to develop and internationalize the Chinese currency. These have included the rapid expansion of the Offshore Yuan (CNH), essentially a proxy for the conventional yuan but subject to fewer capital controls. Yuan-denominated trade settlements have been rolled out on a nationwide basis. Beijing recently sanctioned yuan-denominated foreign direct investment and is discussing a yuan trade settlement agreement with ASEAN. It has also given its blessing to Nigeria's use of the yuan as a reserve currency, a largely symbolic move at this point, but an important signal of changing attitudes to the currency both inside and outside of China.

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