In recent testimony by Douglas Holtz-Eakin, the director of the Congressional Budget Office (CBO) before the House Ways and Means Committee, Mr. Holtz-Eakin presented CBO analysis that demonstrated the small and transitory effect of forcing China into revaluing the Yuan from its fixed exchange rate of 8.28 Yuan to the U.S. Dollar. The CBO analysis showed that, not only would a revaluation of the Yuan increase manufacturing employment only slightly for a short period of time, it found that most of the bilateral trade and current account deficits with China would be shifted to other countries, with very little impact on the overall multilateral trade and current account deficits. While these effects are probably the most influential to U.S. policy-making, the effect of the forced revaluation of the Yuan on the Chinese economy is more important overall to the world economic situation. The CBO notes that, because of the weak banking system in China and the possibility of large capital outflows if the exchange rate is allowed to float and capital controls are eased, the forced revaluation might lead to a depreciation of the Yuan. This would make the policy in terms of the U.S. goals a failure. Furthermore, and probably more important overall, is that the devaluation of the Yuan might cause many banks to fail due to their high level of non-performing loans (loans not being repaid or in default). This could cause a repeat of the Asian crisis of 1998 for China, which would likely spill over to other Asian economies and hurt their long-term growth prospects. Because Asian economies are large markets for U.S. exports, this could cause an increase in the U.S. trade deficit (lower levels of U.S. exports for similar levels of imports). The fall in U.S. exports would harm the prospects of coming out of the jobless recovery that has characterized the U.S. economy since the recession ended in November 2001. Between the small positive effect on the U.S. economy (in the best-case scenario) and the possibility of large negative effects on Asian economies suggest that U.S. policy of forcing a revaluation of a (possibly) undervalued Chinese Yuan is misguided and will have a net negative effect on the world economy.
Holtz-Eakin, Douglas "The Chinese Exchange Rate and U.S. Manufacturing Employment," CBO Testimony before the U.S. House of Representatives Committee on Ways and Means, October 30, 2003.
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©2003 Richard B. Goud, Jr.
Updated on 2 November 2003 at 16:51 PST