Recently, the US government has exerted pressure on China to undervalue its currency. Since 1995, China has kept a fixed exchange rate of $1:8.28 renminbi. Consequently, the US considers China’s fixed exchange rate as a barrier to international adjustment and transmission of price indicators.
This phenomenon creates a risk to the United States’ economy. The legislation that was introduced in the Senate recommends that a tariff be imposed on Chinese imports if China fails to review its fixed exchange rate. According to the sponsors of this bill, 27.5% is the standard rate that must be used to undervalue China’s currency.
Several reasons have been put forward to justify the introduction of this bill. For example, under Article 21 of the General Agreement of Tariffs and Trade, member states of the World Trade Organization are allowed to take any necessary steps to protect their security interests. The argument in support of this bill is that the US interests and its manufacturing sectors are negatively affected by the artificially cheap Chinese imports due to China’s fixed exchange rate (McKibbin and Stoeckel 1).
Some Washington insiders doubts whether the Senate bill will be implemented by the US government. Nevertheless, a number of economists argue that such an action is justified. For example, those in support of this bill suggest that the US manufacturing sector should be granted countervailing duties as a protection against cheap imports from China, including the Chinese fixed exchange rate.
On the other hand, China has conceded that their fixed exchange rate needs to be more flexible. Although they not ready to change their currency policy, they have proposed three solutions to this impasse: raise the foreign exchange trading volume; bolster its financial sector and policies in order to make the sector more elastic to fluctuations in exchange rate; and devise foreign exchange tools for trading currencies as well as currency risk management via hedging (McKibbin and Stoeckel 2).
There is a mixed-up perception among the US legislators about the need for China to adjust its currency policy. The US legislators consider the widening of the US current account and trade deficits; the immense growth of Chinese imports and the lack of proportionate growth of US exports to China as unjust trade and thus the need for China to devalue its currency.
According to some experts, the US current account deficit is caused by the anticipated returns to capital and this phenomenon is simply reflected by trade performance (McKibbin and Stoeckel 2).
As an emerging economic powerhouse, China will not allow to be manipulated by the US. There are several responses that China might adopt in face of hostility about unfair trade and currency revaluation. For example, China may challenge the legitimacy of the action taken by the United States under Article XXI of the GATT.
However, this could take several years before the issue is deliberated on. Alternatively, China could retaliate by enforcing tariffs on some imports from the United States such as Caterpillar earthmoving gear and Boeing airplane in order to consolidate its status among special interests in the US.
Given that it is hard to predict how China will respond to the Senate bill on Chinese imports and currency devaluation; the most probable Chinese response could be the introduction of a general tariff on exports from the United States to China (McKibbin and Stoeckel 3).
Work Cited
McKibbin, Warwick, and Andrew Stoeckel. “What if the US Imposes a Tariff on China’s Exports to Force a Revaluation?” Economic Scenarios. com 11 (2005): 2-8. Web.