CRS (Again): RMB Appreciation Will Have Little Effect on Trade Balance and Overall US Economy

Over the last year or so I've often screamed calmly noted that the unbiased, non-partisan folks at the Congressional Research Service (CRS) have repeatedly examined the US-China currency issue and have repeatedly found that significant appreciation of the RMB will have little effect on the US-China trade balance or overall US economic welfare.  The CRS' latest report (h/t Simon Lester) is a very significant revision to previous versions, so I highly recommend giving the entire thing a skim.  But in case you don't have the time, here are the two most important passages.  First, on the overall effect on the US economy (at pp. 20-21, emphasis mine):

In the medium run, according to economic theory, an undervalued RMB neither increases nor decreases aggregate demand in the United States.  Rather, it leads to a compositional shift in U.S. production, away from U.S. exporters and import-competing firms toward the firms that benefit from Chinese capital flows.  Thus, it is expected to have no medium- or long-run effect on aggregate U.S. employment or unemployment. As evidence, one can consider that the since the 1980s, the U.S. trade deficit has tended to rise when unemployment was falling and fall when unemployment is rising. For example, the current account deficit peaked at 6% of GDP in 2006, when the unemployment rate was 4.6%, and fell to 3% of GDP in 2009, when the unemployment rate was 9.3%.

However, the gains and losses in employment and production caused by the trade deficit will not be dispersed evenly across regions and sectors of the economy: on balance, some areas will gain while others will lose. And by shifting the composition of U.S. output to a higher capital base, the size of the economy would be larger in the long run as a result of the capital inflow/trade deficit (although the returns from foreign-financed capital will not flow to Americans).

Although the compositional shift in output has no negative effect on aggregate U.S. output and employment in the long run, there may be adverse short-run consequences.  If U.S. output in the trade sector falls more quickly than the increases in output of U.S. recipients of Chinese capital, aggregate U.S. spending and employment could temporarily fall.  This is more likely to be a concern if the economy is already sluggish than if it is at full employment. Otherwise, it is likely that government macroeconomic policy adjustment and market forces can compensate for any decline of output in the trade sector by expanding other elements of aggregate demand. The U.S. trade deficit with China (or with the world as a whole) has not prevented the U.S. economy from registering high rates of growth in the past.

A Yale University study estimated that a 25% appreciation of the RMB would initially decrease U.S. imports from China and lead to greater domestic production in the United States and increased exports to China.  However, the study estimated that benefits to the U.S. economy would be offset by lower Chinese economic growth (because of falling exports), which would diminish its demand for imports, including those from the United States. In addition, the RMB appreciation would increase U.S. costs for imported products from China (decreasing real wealth and real wages), and cause higher U.S. short-term interest rates. As a result, the sum effect of the 25% RMB appreciation was estimated to a negative effect on U.S. aggregate demand and output and result in a loss of 57,100 U.S. jobs—less than one-tenth of 1% of total U.S. employment.

Second, on the bilateral trade balance (at p. 24):

None of the [currency] solutions guarantee that the bilateral trade deficit will be eliminated. China is a country with a high saving rate, and the United States is a country with a low saving rate; it is not surprising that their overall trade balances would be in surplus and deficit, respectively. As the Appendix discusses, many economists believe that these trade imbalances will persist as long as underlying macroeconomic imbalances persist. At the bilateral level, it is not unusual for two countries to run persistently imbalanced trade, even with a floating exchange rate. If China can continue its combination of low-cost labor and rapid productivity gains, which have been reducing export prices in yuan terms, its exports to the United States are likely to continue to grow regardless of the exchange rate regime, as evidenced by the 21% appreciation of the RMB from 2005 to 2008 which did not lead to any reduction in the trade deficit over that period.

Good stuff.  The Report's authors also explain in great detail: (i) why it's difficult, if not impossible, to determine whether China's currency is undervalued and the precise extent of that undervaluation; (ii) why a significant appreciation of the RMB probably won't affect the US-China trade balance, could make Chinese producers more, not less, competitive, and could harm American consumers, import-using manufacturers and borrowers; (iii) why China hasn't allowed its currency to float freely (hint: it has nothing to do with predatory trade practices); and (iv) why transitioning to a market-based currency is in China's long-term economic interests.  The authors even document scholarly arguments against the United States' making China's currency its top trade policy priority, and they calmly explain that doing nothing will eventually take care of the "imbalance" problem ("Even without adjustment to the nominal exchange rate, over time the real rate would adjust as inflation rates in the two countries diverged").

All in all, the CRS report is a solid assessment of the economic facts and policy arguments surrounding the China currency issue, and it makes clear that 99% of what you hear on the issue from the White House, Congress and (unfortunately) a lot of reporters and pundits out there is totally and utterly wrong.

Now, if only I could recall where we've heard all of this before.  Oh, right.