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January 22, 2004 Dear Vice President Cheney: We believe China's currency policies and the deep undervaluation of its currency, the yuan or renminbi, have not only contributed to job loss and business failure in the United States, but they are also leading to major international exchange rate and trade imbalances and have become a destabilizing force in the global economy. In your capacity as the leader of the U.S. delegation, we respectfully urge you to make this issue a top priority at the World Economic Forum in Davos, Switzerland. As you know, the macroeconomic effect of the enormous U.S. bilateral trade deficit with China – now $126 billion or 1/4 of our total trade deficit – should be a decline in the value of the U.S. dollar and an increase in the value of the Chinese yuan. Over time, this would serve to "self-correct" the trade deficit: U.S. goods would become cheaper and Chinese goods would become more expensive. However, since China's currency is pegged to the dollar, as the dollar falls, so too does the yuan; no self-correction takes place. In addition, since China sells in many of the same international markets as the U.S., our goods do not gain the export advantage from our falling currency they otherwise might: as their prices fall so do the prices of the Chinese goods they are competing with. This will slow our recovery. Finally, the Chinese government's intervention in the value of the yuan over recent years has led it to purchase dollar denominated assets in massive volumes thus creating sovereign demand for the dollar that does not reflect true market demand. This prevents an orderly decline in the dollar's value and, as pressure builds, puts the dollar at risk of a precipitous fall. China's artificial peg to the dollar has led the Euro to bear the brunt of the dollar's fall. With concern rising about the dollar's value due to the United States' twin trade and budget deficits, currency traders have only one major currency on which to place their bets. Since China's currency value is artificially fixed (and Japan's currency is effectively fixed through massive government intervention), only the Euro provides traders with an opportunity to ride a major currency up as the dollar declines. The result has been a more than 20 percent appreciation in the Euro's value against the dollar over the past year. As the yuan rides the dollar down, Chinese goods are becoming even more competitive in the European markets. This hurts European manufacturers and other major exporters and puts Europe's fragile economic recovery at risk. As the United States' second largest export market, a weakened Europe threatens our own economic recovery. China's undervalued currency also makes a difficult economic situation worse for developing nations. These countries now find themselves competing in already low margin, labor intensive sectors against Chinese goods that are benefitting from a sharply undervalued currency. For example, China's currency-driven trade advantage is giving it dominance in textiles, a critical industry to developing nations. In Pakistan, for example, more than 70 percent of its total exports come from textile production. Likewise, until recently, Mexico had been successfully pursuing an export led growth strategy selling primarily to the U.S. market. However, competition from China has caused Mexico to lose market share in both high and low value products to the point where today China now has a larger share of U.S. imports than Mexico. As China has become more internationally competitive, firms that were investing in developing nations have shifted capital and operations to China. In 2002, foreign direct investment (FDI) in China was $53 billion making it the world's largest destination for FDI; on the other hand, FDI in developing countries fell by more than 25%, according to United Nations statistics. A lack of economic progress in developing nations will lead either to a need for more foreign aid or to conditions that we have tragically seen become the breeding grounds for terrorism. Finally, China's undervalued currency is a risk to its own economy. The expansion of China's money supply, exacerbated by its undervalued currency, is a large factor behind the easy credit and problem loans now plaguing China's financial sector. The Chinese government no doubt believes it can successfully manage the inflationary pressure now building in its economy, but there is evidence that China's economy is overheating and creating a dangerous speculative bubble. As Morgan Stanley's chief global strategist, Barton Biggs, has pointed out, "A country that does not have a free market capital allocation mechanism is uniquely unqualified to mitigate the excesses of an investment boom." Despite many months of concern from members of Congress, as well as efforts by the Administration, the Chinese government has made no changes to its currency policies. The yuan remains fixed at the same rate it has been for over ten years. There have been many statements of good intentions, but no real progress. We have already seen China contribute to one currency crisis when in 1994 it devalued its currency by more than 30 percent causing the major dislocations in the trading flows of east Asia which precipitated the Asian currency crisis. The bottom line is that China's currency practices are not only hurting the United States, they are also threatening the global economy. As Federal Reserve Chairman Alan Greenspan recently observed, the greatest threat to the world economy is "protectionism" and its greatest strength is "flexibility." In the global economy today there may be no more broad based form of protectionism than China's illegal currency manipulation, and there may be no less flexible economic policy than China's decade-old fixed currency value. Mr. Vice President, if China enjoys the benefits of membership in the international economic community, as it clearly has, we hope you agree that it is only fair that it abide by the community's rules and responsibilities. The time for change is now, before the global economy is put further at risk.
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