June 28, 2004

China’s Currency is Undervalued: Second Report from the Fair Currency Alliance

June 28, 2004

China’s Currency is Undervalued: Second Report from the Fair Currency Alliance
Experts Agree: China’s Currency is Undervalued

(Washington, D.C.) (June 28, 2004) – The Fair Currency Alliance (FCA) today released Experts Agree: China’s Currency is Undervalued, the second in a series of briefs focusing on the degree of undervaluation of China’s currency.

“There is consensus among economists worldwide that China’s currency is, and has been, substantially and persistently undervalued,” said David A Hartquist, spokesperson for the alliance. “The undervalued yuan puts U.S. companies at a disadvantage whether competing in the United States, China or elsewhere.”

The alliance’s second brief reflects undervaluation estimates ─ attributed to an array of international banking organizations and financial institutions ─ ranging from a high of 75 percent to a low of 10 percent.

“This artificial and manipulated exchange rate distorts trade and is a further threat to the eroding American manufacturing base,” Hartquist continued. “China should promptly appreciate the value of the yuan by up to 40 percent so that U.S. manufacturers and service providers can compete on a fair and equitable basis.” 

FCA is a coalition of U.S. industrial, service, agricultural, and labor associations working to reverse the injury that the tightly-controlled and undervalued Chinese currency has on U.S. commerce and the global market place.  FCA views China’s exchange rate policies as tantamount to an illegal subsidy and violates their WTO and IMF obligations.  It contends that ─ because the exchange rate does not reflect market conditions ─ American exports to China are artificially priced higher, while Chinese products are priced lower in the U.S. market.  On a global scale, FCA warns that China’s failure to adjust exchange rates in an orderly and timely manner could result in another Asian financial crisis with severe implications for workers, manufacturers and service providers worldwide.

FCA Brief No. 1 focused on China’s inaccurate trade data and how it distorts the degree of currency manipulation. Future topics include the impact that the undervalued yuan has on the Chinese economy and the global financial system; China’s violations of international trade and financial agreements; and steps that the U.S. government should take to ensure parity and fair play.

David A. Hartquist, an international trade attorney with the Washington, DC law firm Collier Shannon Scott, PLLC, serves as counsel to the alliance. 





Date of Publication

Percent Yuan Undervalued

World Bank

PPP Level



Big Mac Index

The Economist

Apr. 2003




Sept. 2002


Yang and Bajeux-Besnainou

Is the Chinese Currency Undervalued?

Nov. 2003

27.99% based on PPP and using 1985 as fixed base year


IIE lecture

Oct. 2003

Over 25%


The Complete RMB Handbook

Oct. 2003

Nearly 25% in real terms


Testimony to Congress

Oct. 2003


O’Neill & Wilson

Goldman Sachs Rpt.

Sept. 2003



Chinese Mercantilism: Currency Wars and How the East Was Lost

July 1998

10-15% as of 1998


In evaluating the degree to which a currency may be undervalued, economists rely heavily on two measures of the relative supply and demand for a given currency — whether foreign-exchange reserves are accumulating and the size of the basic balance of payments.  Each of these key measures indicates a high degree of undervaluation of the yuan.

A country’s foreign-exchange-reserve holdings can be assessed directly from its balance-of-payments data.  A country’s official foreign-exchange reserves fluctuate along with its combined current- and capital-account positions.  Consequently, if a country’s combined current and capital accounts are in surplus, as is overwhelmingly the case for China, there is a net inflow of foreign currency that is reflected by an increase in its official reserves.  In effect, more foreign currency is flowing into the country than out of the country, leading to an accumulation of foreign currency in the form of official reserves.  Increasing official reserves are a clear sign of currency undervaluation, as explained below.

In China’s case, the tremendous increases in U.S. dollars flowing into the country from both its trade surpluses with the United States and its foreign-direct-investment inflows from the United States are met with tight controls by the Chinese government, which has sharply restricted authorized uses of U.S. dollars.  The primary authorized “use” of U.S. dollars is conversion into yuan, which means that there is constant selling of U.S. dollars and buying of yuan in China.  In order to forestall an unwanted appreciation of the yuan vis-à-vis the U.S. dollar, the Chinese government intervenes in the market and purchases any amount of U.S. dollars by “selling” (i.e., printing) any amount of yuan required to keep the value of the yuan narrowly fixed versus the U.S. dollar.  Consequently, the Chinese government’s intervention in the market to buy U.S. dollars at a fixed price indicates that U.S. dollars are in excess supply at the prevailing rate of exchange; otherwise, the market would clear on its own and make unnecessary that the government be the demander of last resort.  Thus, China’s soaring official foreign-exchange reserves clearly confirm the undervaluation of the yuan.

Since official reserve positions can fluctuate or be skewed temporarily by factors unrelated to underlying supply-and-demand forces, economists often rely on a second measure — the country’s basic balance of payments — as further confirmation of relative currency valuations.  Before turning to this additional indicator, however, it must be emphasized that China’s massive accumulation of foreign-exchange reserves cannot be described either as a fluctuation or temporary in nature.  Indeed, these huge and growing reserves are a direct product of the Chinese government’s interference in the foreign-exchange market and its refusal to permit market forces to mediate supply and demand.  As a result, the government has created a gaping imbalance between supply and demand that it must neutralize in order to keep the yuan from appreciating.

A country’s basic balance of payments is a subset of its overall balance of payments.  The so-called “basic balance” is the sum of the country’s current account (mainly its trade balance) plus the non-short-term portion of its capital account.  In relation to the overall balance of payments, the basic balance ignores short-term financial and portfolio flows, as well as net purchases or sales of official reserves by monetary authorities.  Due to China’s strict capital-account controls, however, the non-short-term portion of its capital account is confined almost entirely to foreign-direct-investment inflows.  Consequently, China’s basic balance is essentially the aggregate of its current account and foreign-direct-investment inflows.

Economists rely on the basic balance as a straightforward gauge of a country’s financial relationship with the rest of the world.  China’s basic balance has been consistently positive for many years and is excessive relative to its Gross Domestic Product (“GDP”).  Combining China’s trade surplus, which annually has averaged nearly U.S. $40 billion (according to China’s data) to as much as U.S. $150 billion (according to the data reported by China’s major trading partners, as detailed in Brief No. 1) and China’s U.S. $40-50 billion of annual foreign-direct-investment inflows results in an estimated basic balance annually in the range of U.S. $80 billion on the low end to U.S. $200 billion on the high end.  China’s basic balance, therefore, represents at least 5 percent of its GDP according to China’s own data.  While this figure is astonishing in its own right, the data from China’s major trading partners suggest that the ratio between China’s true basic balance and its GDP is likely several times higher.

According to both these key measures, therefore, the yuan is clearly undervalued.  The Library of Congress’ Congressional Research Service agreed that the yuan was undervalued, in it’s study,  “China’s Exchange Rate Peg:  Economic Issues and Options for U.S. Trade Policy.”  .  However, the CRS study, although it serves as a good summary of current undervaluation estimates, is critical of all, in general citing their reliance on non-empirical assumptions to fix an equilibrium point as to China’s current-account balance and the difficulty of deriving such an equilibrium point in the presence of the comprehensive capital controls exercised by the Chinese authority.  Indeed, a recurring theme in the relevant analyses of China and the role of its exchange rate in its recent trade performance and balance-of-payments position centers on the lack of reliable benchmarks against which objective measurements can be made, not to mention inferences drawn as to causes, effects or even basic trends.  In short, extensive and pervasive Chinese governmental interference in markets, both in the past and present, coupled with often dubious statistical data available on the Chinese economy and financial markets, makes even general conclusions and assessments haphazard at best.  Consequently, rather than focus unduly on one particular analysis or methodology, it is perhaps more instructive to view the less disputable results.  Not even CRS disputes that the yuan’s exchange rate has remained frozen for more than eight years despite a massive increase in the supply in U.S. dollars vis-à-vis the yuan, now reflected in China’s large and rapidly growing foreign-exchange holdings and investments in U.S. governmental debt instruments.

Thus, technical critiques of the imprecision of the extent of the yuan’s undervaluation are not the focus of this discussion.  The purpose here is to establish (a) that there is a widespread consensus among economists that the yuan is undervalued and (b) that the various estimates cited, even acknowledging some imprecision, generally are ranged closely and find significant undervaluation of the yuan.  Placed within the context of currency movements, which typically fluctuate by only a fraction of a percent or two over many months, all of the estimates listed above indicate that the yuan is significantly undervalued. These estimates also show how the rumored contemplation by China of a five-percent upward revaluation would be totally inadequate and likely to lead only to increased speculative pressure on the yuan.