Renminbi Undervaluation, China's Surplus, and the US Trade Deficit

Policy Brief
August 2010

The impact of China's exchange rate on both its current account balance and the US-China bilateral trade balance is considerable. A 1 percent rise in the real effective exchange rate would cause a reduction in China's current account surplus of 0.30 to 0.45 percent of GDP. A 10 percent real effective appreciation would bring China's current account surplus down by roughly $170 billion to $250 billion annually with a corresponding improvement in the US current account balance ranging from $22 billion to $63 billion annually. William R. Cline also warns that the increasing trend for China's current account surplus, combined with the negative trend for the US deficit, indicate that adjustments accomplished through exchange rate correction at any one time will have a tendency to erode unless the renminbi successively appreciates by around 2 percent annually to reflect its rapid productivity growth. Special Chinese efforts to shift the economy away from external to domestic demand are important complements of exchange rate adjustment, without which the long-term trend toward a rising trade surplus could cause excess demand to grow and increase inflationary pressures on the economy.