Undervalued Currency Research Articles

The Rising U.S. Trade Deficit With China And Why It Wont Go Away

During the latter half of 1998, Laura D'Andrea Tyson, former chairwoman of the President's Council of Economic Advisers and economics professor at Berkeley, wrote a highly-publicized commentary that questioned whether China would replace Japan as the antagonist in Americas trade deficit woes. She stated "As the U.S. trade deficit with China continues to increase, concerns mount that China will soon replace Japan as America's major trade headache. Such concerns are fed by an image of China as another Japan - a country pursuing a mercantilist development strategy based on closed markets, an undervalued currency, and a structural trade surplus." Highlighting Japans closed markets, undervalued currency, and perennial trade surplus, Tysons monograph calls into question whether China's trade practices will parallel the manic logic of mercantilism so vehemently practiced by Japan. This paper examines the burgeoning supremacy characteristic of modern Chinas export-oriented trade program and provides useful, suggestive commentary on how U.S. trade policy with China should be handled, drawing conclusively from the Japanese experience. Finally, the causes underpinning the rising U.S. import/export ratio with China will be investigated.

Is China’s Currency Regime A Countervailable Subsidy? A Legal Analysis Under the World Trade Organization’s SCM Agreement

Members of Congress are currently threatening to enact legislation authorizing the US Department of Commerce to investigate China’s allegedly undervalued currency as a countervailable subsidy. If this happens, then China will very likely challenge the United States at the World Trade Organization’s (WTO’s) dispute settlement mechanism. This paper analyses whether a countervailing duty (CVD) applied to China’s currency regime would be consistent with the WTO’s Subsidies and Countervailing Measures (SCM) Agreement. Contrary to many commentaries, this paper concludes that, while there are several significant potential obstacles, there are in fact legitimate arguments that a WTO panel could use to uphold a US-imposed CVD on China’s undervalued currency.

Endogenous inflows of speculative capital and the optimal currency appreciation path

Abstract This paper examines the optimal appreciation path of an undervalued currency in the presence of speculative capital inflows that are endogenously affected by the appreciation path. A central bank decides its appreciation policy based on three costs: (i) misalignment costs associated with the gap between the actual and long‐run equilibrium exchange rates, (ii) short‐term adjustment costs due to resource reallocation, and (iii) capital losses due to speculative capital inflows. Our model finds (1) when speculators face no liquidity shocks, the central bank tends to appreciate the currency quickly to discourage speculative capital; (2) when speculators face liquidity shocks, the central bank optimally pre‐commits to a slower appreciation path, and the appreciation takes the longest time when the probability of liquidity shocks takes intermediate values; (3) the central bank tends to appreciate the currency more quickly when it conducts discretionary policy.

Exchange rate policy, growth, and foreign trade in China

This paper analyzes a hot topic: the influence of an undervalued currency on macroeconomic variables - primarily on the economic growth and trade balance of a country, but also on employment, foreign exchange reserves, competition, and living standards. It also reviews and explains the consequences of yuan undervaluation, points out the need for its appreciation, and states the negative effects that stem from this measure. Special attention is given to the problematic bilateral relations between China and the USA and the reasons why Americans are worried about the exchange rate policy that China implements. Although yuan appreciation would decrease the American foreign trade deficit, it also raises the question of further financing of the American deficit. There are also other problems that the possible appreciation would cause for the American economy, due to the effect of J-curve, passthrough, larger costs of input imported from China, etc. Therefore, Chinese foreign exchange policy is an important subject, but it is not the solution to the problems of the global economy - which have deeper roots than that. However, there is no excuse for China implementing unfair exchange rate policies, or replacing such policies with controversial protectionist policies (as some authors have suggested).

Beyond cheap talks: Assessing the undervaluation of the chinese currency between 1994 and 2007

Résumé Recourant à l’approche comportementale du taux de change d’équilibre (BEER), cet article estime le taux de change réel d’équilibre du Renminbi (RMB) et le mésalignement de change correspondant en Chine, pour la période allant du 1 er trimestre 1994 au 4 ème trimestre 2007. Au niveau méthodologique, l’analyse s’appuie sur la cointégration avec ruptures structurelles, introduite par Johansen et al. (2000). Le principal résultat est que le RMB était surévalué pendant la crise financière asiatique et durant les années 2001-2002. Dans une certaine mesure, il n’était sous-évalué que sur la période récente, 2003-2005, sauf au début de notre échantillon ; de plus, de légères surévaluations ont été constatées après la mise en place du nouveau régime de change en 2005. Diverses explications sont suggérées afin d’expliquer ces variations. Classification JEL : F31 ; F32 ; F41 ; C32.

Manipulating the WTO? Challenging Undervalued Exchange Rates Under WTO Rules

The Chinese exchange rate policy is a hotly debated topic. Comments are heard from politicians, economists and lawyers alike, with fingers pointed at the Renminbi (RMB) undervaluation blaming it for job loss in the United States or for causing the credit crisis by creating global imbalances and a search for yield through a low interest rate environment. Most of the criticism focuses on the trade effects of undervalued currencies, where an unfair trade advantage is gained by China “manipulating” its currency. This paper investigates what options exist under WTO/GATT provisions for members that would like to take trade actions against countries that have undervalued currencies. It will be put forward that the WTO rules do not provide the solution for countering the trade effects of undervalued currencies. The only correct forum for dealing with exchange rate issues and undervaluation is the IMF.

Do Currency Fundamentals Matter for Currency Speculators?

The answer seems affirmative. We compare currency carry trades with an investment strategy based on currency fundamentals: taking a long (short) position in undervalued (overvalued) currencies. Carry trades have high risk-adjusted returns, but are subject to risk. In contrast, the fundamental strategy has lower risk-adjusted returns, but is less prone to crash risk, because the realization of crash risk coincides with corrections towards fundamentals. In particular, the fundamental strategy outperformed carry trades during the recent global financial crisis. Building on these results, we present early warning indicators for potential turbulence in the currency market.

Do Currency Fundamentals Matter for Currency Speculators?

The answer seems affirmative. We compare currency carry trades with an investment strategy based on currency fundamentals: taking a long (short) position in undervalued (overvalued) currencies. Carry trades have high risk-adjusted returns, but are subject to risk. In contrast, the fundamental strategy has lower risk-adjusted returns, but is less prone to crash risk, because the realization of crash risk coincides with corrections towards fundamentals. In particular, the fundamental strategy outperformed carry trades during the recent global financial crisis. Building on these results, we present early warning indicators for potential turbulence in the currency market.

Nonlinear adjustment of the real exchange rate towards its equilibrium value: A panel smooth transition error correction modelling

We study the nonlinear dynamics of the real exchange rate towards its behavioral equilibrium value (BEER) using a Panel Smooth Transition Regression model framework. We show that the real exchange rate convergence process in the long-run is characterized by nonlinearities for emerging economies, whereas industrialized countries exhibit a linear pattern. Moreover, there exists an asymmetric behavior of the real exchange rate when facing an over- or an undervaluation of the domestic currency. Finally, our results suggest that the real exchange rate may be unable to unwind alone global imbalances.

Renminbi Misaligned - Results from Meta-Regressions

We collect data from 29 separate papers estimating the equilibrium level and possible undervaluation of the Chinese currency, the renminbi. These papers yield a total of 97 individual observations on misalignment, which we analyse with the help of meta-analysis. We find that the vast majority of observations point to renminbi undervaluation in recent years and that the undervaluation is more pronounced when the US dollar exchange rate is used instead of the real effective exchange rate. We find several characteristics of papers and authors that clearly seem to influence the reported misalignments. For example, when the author is affiliated with an investment bank, the reported misalignment is smaller. Using time-series techniques also results in lower estimates of undervaluation. On the other hand, refereed journals seemingly are inclined to publish papers that report larger misalignments. Results caution against trusting too much in any one study concerning renminbi undervaluation.

Currency Undervaluation and Sovereign Wealth Funds: A New Role for the World Trade Organization

Two aspects of global imbalances – undervalued exchange rates and sovereign wealth funds – require a multilateral response. For reasons of inadequate leverage and eroding legitimacy, the International Monetary Fund has not been effective in dealing with undervalued exchange rates. This paper proposes new rules in the World Trade Organization to discipline cases of significant undervaluation that are clearly attributable to government action. The rationale for WTO involvement is that there are large trade consequences of undervalued exchange rates, which act as both import tariffs and export subsidies, and that the WTO's enforcement mechanism is credible and effective. The World Trade Organization would not be involved in exchange rate management, and would not displace the International Monetary Fund. Rather, the authors suggest ways to harness the comparative advantage of the two institutions, with the International Monetary Fund providing the essential technical expertise in the World Trade Organization's enforcement process. There is a bargain to be struck between countries with sovereign wealth funds, which want secure and liberal access for their capital, and capital‐importing countries, which have concerns about the objectives and operations of sovereign wealth funds. The World Trade Organization is the natural place to strike this bargain. Its General Agreement on Trade in Services already covers investments by sovereign wealth funds, and other agreements offer a precedent for designing disciplines for these funds. Placing exchange rates and sovereign wealth funds on the trade negotiating agenda may help revive the Doha Round by rekindling the interest of a wide variety of groups.

External adjustments and coordinated exchange rate policy in Asia

In this paper, we estimate structural VAR models with contemporaneous restrictions based on neo-classical and Keynesian theories to investigate whether the cause of current account surpluses for East Asian economies is a “saving glut” or undervalued currencies. Analytical results show that the major determinant of the current account is the real effective exchange rate for all East Asian countries with the exception of China for which the major determinant is domestic GDP. Accordingly, the recently requested revaluation of the Chinese yuan may not be an effective policy for reducing the Chinese current account surplus, and may affect other Asian current accounts. We also investigate whether a Chinese currency revaluation would contribute to the improvement of current account imbalances in East Asia and find that a revaluation would, indeed, improve the current accounts of Japan, Korea, Indonesia, and Thailand. Since the trade structures of major East Asian countries are substitutes with that of China, a Chinese currency revaluation might not lead to a decrease in East Asian current account surpluses. Coordination of currency policy among East Asian countries is, therefore, needed to solve the global current account imbalance.

Evaluating Historical CGER Assessments: How Well Have they Predicted Subsequent Exchange Rate Movements?

The IMF's Consultative Group on Exchange Rate issues (CGER) has been conducting exchange rate assessments as part of the surveillance process since 1997. This paper evaluates CGER assessments from 1997 to 2006, by comparing these to subsequent movements in real effective exchange rates (REER). We find that CGER's estimated misalignments have predictive power over future REER movements, especially over longer horizons and after changes in fundamentals are accounted for. But while CGER misalignments frequently predict the direction of currency movements correctly, misalignments have tended to be persistent, resulting in systematic errors-overprediction for undervalued currencies and underprediction for overvalued currencies.

Evaluating Historical CGER Assessments: How Well Have They Predicted Subsequent Exchange Rate Movements?

The IMF's Consultative Group on Exchange Rate issues (CGER) has been conducting exchange rate assessments as part of the surveillance process since 1997. This paper evaluates CGER assessments from 1997 to 2006, by comparing these to subsequent movements in real effective exchange rates (REER). We find that CGER's estimated misalignments have predictive power over future REER movements, especially over longer horizons and after changes in fundamentals are accounted for. But while CGER misalignments frequently predict the direction of currency movements correctly, misalignments have tended to be persistent, resulting in systematic errors-overprediction for undervalued currencies and underprediction for overvalued currencies.

The new exchange rate policy in the Asian emerging economies – goodbye trouble, hello comfort?

In this paper, we discuss new aspects of exchange rate policy that can be observed in the Asian emerging economies. In the first place, we show the alternative regimes they may choose and their respective pros and cons. Secondly, we concentrate on the recent strategy of systematic undervaluation of one's currency – figuring prominently among ‘big’ Asian players such as China and India – and the most likely implications of such a strategy for domestic allocation, distribution and stabilization goals. With the background of Germany's experiences in 1969, almost on the eve of the Bretton Woods' system collapse, we model a speculative attack on an undervalued currency in the vein of the Flood–Garber seminal paper from 1984. Now, however, the country in concern (just like India and China) possesses strong rather than weak fundamentals. The continuous accumulation of international reserves, in addition, leads to the question of an ‘optimal management’ of foreign exchange reserves in Asian emerging economies with regard to size and composition. We finally propose a sequence of reforms/policies that should be implemented in those Asian emerging economies on their still long journey to a regime featured by autonomous monetary policy, flexible exchange rate and capital mobility. A brief summary and an outlook for future research close the paper.

Asia Looms over Latin America

An anecdote from business circles in Latin America tells of a textile manufacturer in El Salvador, who, reeling from Chinese competition, travels to China and visits the sprawling plant of one of his competitors. He knows that Chinese labor costs are only a third of his costs. And he knows, too, that the undervaluation of the Chinese currency gives the country's exporters another cost advantage in world markets, some calculating it to be 10 percent. What amazes him the most, though, is his visit to the floor of the Chinese textile plant. It is huge, with many economies of scale. The equipment is new, the technology sophisticated. As the Salvadoran businessman takes it all in, he suddenly notices that none of the workers-all women-is wearing glasses. He asks, "How is it that none of your employees wear glasses?" "Oh no," he is told, "as soon as the women develop problems with their eyes we get rid of them.

The Dynamism of Mexican Exports: Lost in (Chinese) Translation?

Summary This paper analyzes the extent to which Mexican exports have penetrated US markets in recent years, and juxtaposes such an analysis with the performance of China. We find that Mexico’s main non-oil exports are losing dynamism, and their relative share in the US market is either declining or growing slower than China’s. This trend is a new one, and begins after China’s entry into the WTO. A number of factors could explain these findings. These include: (i) the real appreciation of the real exchange rate of the peso relative to the US dollar combined with the trend toward undervaluation of the Chinese currency, (ii) the decline of public investment in Mexico, especially in infrastructure, (iii) limited access to bank credit in Mexico, and (iv) the absence of government policy in Mexico to help spur technological innovation and to strengthening its domestic backward and forward linkages.

Government Bankruptcy of Balkan Nations and their Consequences for Money and Inflation Before 1914: A Comparative Analysis

Government bankruptcies in the countries of the so-called periphery during the period of the gold standard were no rare events. They were also not limited to the Ottoman Empire and the Balkan countries. Prominent examples outside this region were Peru, Brazil, Argentina and Portugal.In this paper a difference is made between open and hidden or veiled government bankruptcies. The latter are happening if budget deficits are covered by substantial money creation leading to inflation. In this case non-indexed government debt loses its value and is inflated away. This path is not open, if the debt is not denominated in the national but in a stable foreign currency or in units of gold or silver. This is usually the case for debt owed to foreigners. But sometimes both kinds of government bankruptcies are occurring together.In the present paper several general qualitative hypotheses are tested for the Balkan countries and the Ottoman Empire: First, that the abolishment of fixed exchange rates is usually the consequence of budgetary deficits leading to inflation. Second, that in this case an undervaluation of the national currencies develops. Third that by contrast an overvaluation arises if only a mild inflation is caused in this way, so that the fixed exchange rate can be maintained.And fourth, that with an open bankruptcy relative to foreign owed debt a kind of crisis develops which finally leads to an international agreement reducing the amount of the debt, or of the interest rate paid on it. Another feature of this agreement may be the institution of more or less far-reaching foreign control of the fiscal and monetary policies of the debtor country.

US Presidential Election 2008: Policy Implications for US—China Trade and Investment

AbstractThe next US president will be elected in November 2008. Since the relative stabilization of war in Iraq, the economy has become the national priority of the 2008 US election. In their campaign efforts, the Democrats have enjoyed greater momentum than the Republicans, in terms of polls, fund‐raising and corporate support. After the Bush era, the next president will seek to restore America's leadership and to engage in multilateralism. Since the 1990s, China has been the most rapidly‐growing US export destination. In terms of US—Chinese trade and investment, the next president, if a Democrat, will, among other issues, review trade agreements and has pledged to co‐sponsor legislation that would allow US companies to seek anti‐dumping duties on Chinese imports based on the perceived undervaluation of the Chinese currency. If a Republican, the next president will support global integration and oppose protectionist measures. The Democratic Congress is likely to oppose Republican policies in general and free trade policies in particular. Both scenarios imply increasing pressure on US—Chinese trade and investment relationships. Because these two nations now account for almost half of global growth, the state of the futureUS—Chinese bilateral relationship has worldwide implications.

Entry rates and the risks of misalignment in the EU8

New member states will join the EMU in the coming years. Setting the central parity at which they will join has been and will be a challenging task, as there is a considerable amount of uncertainty, both from a theoretical and an empirical perspective, surrounding the determination of the optimal exchange rate. Given the probable difficulty in evaluating the equilibrium rate it is thus advisable to focus on the effects of a misalignment of the entry rate for the economy, as it has implications for countries’ real and nominal convergence. An overvalued exchange rate would have an adverse impact on a country's competitiveness and its growth, while an undervalued currency would contribute to an overheating of the economy and an excessive inflation. The objective of this paper is to better understand the role of the entry rates for short run inflation and GDP developments and their implications for the inflation criterion and the real convergence process. Having estimated equilibrium exchange rates for eight out of ten countries that entered the EU in May 2004: Czech Republic, Estonia, Hungary, Lithuania, Latvia, Poland, Slovenia and Slovakia we conduct simulations showing what their adjustments to equilibrium would be if their entry rates deviated from the optimal ones.