Renminbi Undervaluation and the U.S.-China Bilateral Trade Balance

Abstract

This paper examines the impact of the fixed exchange rate policy and the undervaluation of the Chinese currency (Renminbi) on the U.S.-China bilateral trade balance. Due to China's fixed exchange rate policy during the last decade, many have suspected that the Renminbi has been undervalued, and that this undervaluation has contributed to the expansion of the U.S. trade deficit. Based on previous studies, the first part of this paper explores Chinese economic policy and the possible consequences of the fixed exchange rate and the undervaluation of the Renminbi. The second part of the paper examines the following through empirical analysis: (1) the misalignment of the Renminbi through the behavioral equilibrium exchange rate (BEER) approach, (2) the relationship between the real exchange rate of the Renminbi and the U.S.-China bilateral trade balance and (3) the relationship between the undervaluation and the US bilateral trade deficit with China. The results indicate that the undervaluation of the Renminbi is neither substantial nor permanent. Moreover, the devalued Renminbi does not significantly increase China's trade surplus with the United States. The U.S. bilateral trade deficit with China is not permanently adversely affected by Renminbi undervaluation.