Question

The relationship between China and the United States is often in the news. To refresh your memory, here are four facts about the Chinese economy: 1. China manages its exchange rate with the dollar. 2. China runs a trade surplus with the United States. 3. The Chinese central bank owns a large number of U.S. Treasury bills. 4. Individual Chinese residents are not free to invest their savings in foreign countries as they would like. Any movement away from a managed exchange rate would probably include a relaxation of these restrictions.

Now evaluate the following claims below with three to five sentences for each. You should also feel free to use graphs or equations where appropriate. Your goal is to discuss why the claim is true, partially true, or not true at all.

i. “Cheap imports from China come a steep cost – lost jobs and lower wages for American workers.”

ii. “Over time, the Chinese government can maintain an unfair trading relationship with the United States by pegging its currency to the dollar at a low level.”

iii. “In the long run, if China continues to peg its currency to the dollar at an abnormally low value, it may incur a significant increase in its price level.”

iv. “The only way for the United States to close its bilateral trade deficit with China is to either raise national savings in the U.S. or reduce investment in new plant and equipment in the U.S.”

v. “Because China has a fixed exchange rate, it is unable to conduct discretionary monetary policy.”

vi. “If China stopped managing the value of its currency, the value of China’s currency would strengthen relative to the dollar and U.S. interest rates would rise.

Please answer all parts!!!!!

Answer 1

i. “Cheap imports from China come a steep cost – lost jobs and lower wages for American workers.”

Ans: This statement is not true at all

In long run, the supply schedule decides the requirement of labour and not trade policy. This means that the number of jobs does not depend on trade policy. Moreover, as per the theory of the comparative advantage indicates that trade makes countries better off, and thus the country as a whole is better off when receiving inexpensive goods from overseas. However, this practice may make some workers jobless and some to work at lower rate. Hence we can say that the Chinese imports comes at steep cost of some worker and not whole nation.

ii. “Over time, the Chinese government can maintain an unfair trading relationship with the United States by pegging its currency to the dollar at a low level.”

Ans: This statement is not true t all

A country’s net exports (NX) are determined by its savings less investment (S ? I), and not by trade policy. The real exchange rate (e) adjusts to bring this equality about. Because it is a real exchange rate, a country cannot peg e in the long run. However, China may be able to peg the currency in the short run (while prices are sticky). If so, then the country might be able to affect trade flows over that horizon. Of course, whether you think this is “unfair” depends on your views of how imports affect the U.S.

iii. “In the long run, if China continues to peg its currency to the dollar at an abnormally low value, it may incur a significant increase in its price level.”

Ans: This statement is true

It concerns the inability of the Chinese government to peg the real exchange rate in the long run. If the Chinese government is pegging the exchange rate at an abnormally low value, then it must be expanding the domestic money supply more than it otherwise would. Higher money tends to raise the price level, and this is the mechanism by which the real exchange rate would eventually rise. China may be able to forestall this increase in prices by “sterilizing” its foreign currency intervention, but in the long run, if the real exchange rate is to rise at a constant level of the nominal exchange rate, then 2 this must be accomplished by a rise in the Chinese price level relative to the U.S. price level.

iv. “The only way for the United States to close its bilateral trade deficit with China is to either raise national savings in the U.S. or reduce investment in new plant and equipment in the U.S.”

Ans: This statement is partially true.

An increase in S ? I in the United States would close the U.S. multilateral trade deficit (that is, the total trade deficit run by the United States), but does not necessarily have to have an effect on the bilateral trade deficit that the U.S. runs with China. Of course, since China is a big trading partner with the U.S., a decline in the U.S. multilateral trade deficit would probably involve some shrinkages of the U.S.-China trade deficit as well. In any case, the only way for the U.S. to close the multilateral trade deficit is to raise S ? I.

v. “Because China has a fixed exchange rate, it is unable to conduct discretionary monetary policy.”

Ans: This statement is false.

The “irreconcilable trinity” of open-economy macroeconomics is that a country must choose two options among the following three: A fixed exchange rate, the ability to perform discretionary monetary policy, and open capital markets. China has chosen the first two and has therefore imposed controls on the ability of its citizens to invest abroad (and on foreigners to invest directly in China). This means that it can pursue discretionary domestic monetary policy.

vi. “If China stopped managing the value of its currency, the value of China’s currency would strengthen relative to the dollar and U.S. interest rates would rise.

Ans: This statement is partially true.

The Chinese central bank would reduce its purchases of U.S. Treasury bills, which would shrink the amount of Chinese currency that wants to turn itself into dollars. The dollar would fall at the same time that interest rates in the U.S. would rise (due to the decline in price of U.S. Treasury bills and the resulting increase in Treasury yields). However, if China relaxed its capital controls at the same time that it relaxed its peg, then individual Chinese residents would probably want to invest some of their savings abroad, including in dollar-denominated assets like U.S. bank accounts and the equity and debt of U.S. firms. This outflow of savings would be new source of Chinese currency that wanted to turn itself into dollars. Consequently, the U.S. dollar may not decline as much as some people have argued. The dollar might even strengthen.