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Tom Holland

At first glance it looks as if the China bashers in Washington are finally seeing their wishes come true.
For years, a powerful cadre of congressmen and think-tank economists in the US capital have blamed America's swelling trade deficit with China on the undervaluation of the yuan.
They accuse Beijing of intervening in the foreign exchange market to keep the yuan artificially low in order to steal an unfair price advantage for China's exports in world markets. The result, as they see it, is America's bilateral trade deficit with China.
They have long argued that Beijing should allow the yuan to rise towards its fair value, in the belief that if it does China's trade surplus - and the US deficit - will shrink in response.
Now it appears as if that may be happening. Over the last nine months, China's central bank has resumed the gradual appreciation of the yuan, letting the currency rise by 4 per cent against the United States dollar.
That means the yuan has now appreciated by 26 per cent against the US currency since mid 2005, when the Chinese authorities ditched their peg to the greenback in favour of a crawling appreciation (see the first chart below).
That's roughly the amount by which Washington's China bashers claimed the yuan was undervalued in the first place. So if they were right that the yuan's undervaluation was the cause of China's trade surplus, then we should be seeing signs by now that the surplus is shrinking.
And on the face of it, that's exactly what's happening. In fact, in February China actually recorded a trade deficit of US$7.3 billion (see the second chart).
Granted, February's trade data was distorted by the Lunar New Year holiday. Factories rushed to get their shipments away before the holiday, and then shut down production for an extended break, resulting in a steep fall in exports in February, compared with the previous month. 
But if you combine February's figures with January's, China still showed a deficit of US$850 billion over the first two months of the year; a stunning reversal for a country used to notching up monthly surpluses of US$20 billion or more.
But how much the appreciating value of the yuan has to do with China's slide into a trade deficit is debatable. In the short term, China's poor trade performance over the first two months of this year has more to do with higher commodity prices than with a stronger currency. The steep rise in the oil price to more than US$100 a barrel pushed up China's energy import bill, tipping the total balance into an unexpected deficit.
But some researchers do believe the yuan's appreciation is having an impact on China's trade balance. For example, Yu Miaojie  of the China Centre for Economic Research  at Peking University claims that the rise in the value of the yuan against the US dollar between 2005 and 2008 'significantly reduced' US imports from China. Yu argues that further appreciation will see the bilateral trade imbalance between the countries narrow further, easing trade tensions.
Unfortunately, it's hard to share Yu's optimism. Theoretical models might show that a stronger yuan led to diminished US demand for Chinese-made goods. But the hard data paints a different picture. Between mid 2005 and mid 2008, the yuan strengthened by just over 20 per cent against the US dollar. Over the same period, the US trade deficit with China expanded from roughly US$17 billion a month to US$25 billion a month (see the third chart). That hardly counts as a significant reduction.
And there are some good reasons to think that the effect of yuan appreciation on China's overall trade surplus will be no more discernable. That's because the expansion of China's trade surplus over recent years is entirely attributable to the growth of its processing trade: importing components for assembly and re-export as finished products.
Now, demand for goods assembled in China is indeed affected by the yuan's exchange rate. Research by the Asian Development Bank Institute  estimates that every 10 per cent inflation-adjusted rise in the yuan leads to a 9.6 per cent fall in China's processing exports.
But if demand for China's processing exports fall, then so does China's own demand for imported components. As a result, the impact of yuan appreciation on China's overall balance of trade is 'very limited'.
In other words, the China bashers are likely to see their hopes dashed over the coming months as China's structural trade surplus re-emerges, despite a continued appreciation of the yuan.



China's slide into a trade deficit is nothing to do with the yuan