International Trade: Treasury Assessments Have Not Found Currency Manipulation, but Concerns about Exchange Rates Continue
Published: 2005-04-19T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The 1988 Trade Act requires the Department of the Treasury to annually assess whether countries manipulate their currencies for trade advantage and to report semiannually on specific aspects of exchange rate policy. Some observers have been concerned that China and Japan may have maintained undervalued currencies, with adverse U.S. impacts, which has brought increased attention to Treasury's assessments. In 2004, Congress mandated that Treasury provide additional information about currency manipulation assessments, and Treasury issued its report in March 2005. Members of Congress have continued to propose legislation to address China currency issues. We examined (1) Treasury's process for conducting its assessments and recent results, particularly for China and Japan; (2) the extent to which Treasury has met legislative reporting requirements; (3) experts' views on whether or by how much China's currency is undervalued; and (4) the implications of a revaluation of China's currency for the United States. In commenting on a draft of this report, Treasury emphasized it does consider the impact of the exchange rate on the economy, and factors influencing exchange rates also affect U.S. production and competitiveness.
section_title: What GAO Found
paragraphs: Treasury has not found currency manipulation under the terms of the 1988 Trade Act since it last cited China in 1994. Treasury officials make a positive finding of currency manipulation only when all the conditions in the Trade Act are satisfied--when an economy has a material global current account surplus and a significant bilateral trade surplus with the United States, and is manipulating its currency with the intent to gain an unfair trade advantage. Treasury said that in its 2003 and 2004 assessments, China did not meet the criteria for manipulation, in part because it did not have a material global current account surplus and had maintained a fixed exchange rate regime through different economic conditions. Japan did not meet the criteria in 2003 and 2004 in part because its exchange rate interventions were considered to be part of a macroeconomic policy to combat deflation. Treasury has generally complied with the reporting requirements for its exchange rate reports, although its discussion of U.S. economic impacts has become less specific over time. Recent reports stress the importance of broad macroeconomic and structural factors behind global trade imbalances, which Treasury officials contend meets the intent of economic impact requirements. Many experts have concluded that China's currency is undervalued, but by widely varying amounts, while some maintain that undervaluation cannot be determined. The significant variation in estimates can be attributed in part to different methodological approaches, but experts also believe that exchange rate assessments are especially challenging for rapidly developing economies such as China's. Among experts who believe China's currency is undervalued, views on policy steps to correct the imbalance differ. A revaluation of China's currency could have implications for various aspects of the U.S. economy, although the impacts are hard to predict. They depend on multiple factors, including how much appreciation is passed through to higher prices for U.S. purchasers and the extent to which reduced imports from China are replaced with imports from other countries. In addition to affecting trade-related sectors, a revaluation could have implications for U.S. capital flows.

section_title: Letter
paragraphs: A significant portion of the recently growing U.S. merchandise trade  deficit—36.4 percent—is made up of large bilateral deficits with China and  Japan. In response to earlier concerns regarding exchange rate policies of  certain Asian countries and their trade with the United States and the  world, Congress passed the Omnibus Trade and Competitiveness Act of  1988 (the 1988 Trade Act), which mandates that the Secretary of the  Treasury annually analyze the exchange rate policies of foreign countries  and consider whether any manipulate their currencies to gain an unfair  trade advantage. A separate provision of the 1988 Trade Act requires that  Treasury report to Congress on specific international economic policy and  exchange rate issues. Some observers are concerned that China and Japan  have intervened in currency markets to maintain an undervalued currency  and that these actions adversely affect U.S. output and employment,  particularly for small manufacturers. Because of these concerns, Treasury’s  currency manipulation assessments have attracted increased attention, and  Congress recently mandated that Treasury report on how statutory  requirements about currency manipulation could be clarified to result in a  better understanding of currency manipulation.
You asked us to review Treasury’s efforts to meet its requirements under  the 1988 Trade Act and related issues. Specifically, we examined (1) the  process Treasury uses to conduct its assessments of currency manipulation  and the results of recent assessments, particularly for China and Japan; (2)  the extent to which Treasury has met the 1988 Trade Act reporting  requirements; (3) experts’ views on whether or by how much China’s  currency is undervalued; and (4) the implications of a revaluation of  China’s currency for the United States.
To determine the process Treasury uses to conduct its assessments of  currency manipulation and recent results, particularly for China and Japan,  we reviewed the 1988 Trade Act, its legislative history, and Treasury’s  analysis of foreign currency manipulation. In addition, we interviewed  responsible Treasury officials to better understand the assessment process  and Treasury’s reasoning behind its analyses for China and Japan. To  determine the extent to which Treasury has met 1988 Trade Act reporting  requirements, we analyzed the reports Treasury has issued since 1988 that  are required by the Trade Act. Finally, to determine experts’ views on  whether or by how much China’s currency is undervalued and the  implications of its revaluation for the United States, we reviewed academic  papers, other studies, and congressional testimonies by economists with  expertise in this area, and we interviewed experts with a range of opinions  on the matter. We also analyzed relevant country economic data and  macroeconomic indicators used by many of these experts. For a complete  description of our scope and methodology, see appendix I. We conducted  our work from September 2003 through February 2005 in accordance with  generally accepted government auditing standards.
subsections: section_title: Background
paragraphs: Congress passed the Omnibus Trade and Competitiveness Act of 1988 (the  1988 Trade Act) to achieve macroeconomic and exchange rate policies  consistent with a sustainable current account balance. The law increases  the executive branch’s accountability for assessing the impact of  international economic and exchange rate polices on the economy.  Congressional concerns at the time included concern that the exchange  rates of other countries placed competitive pressures on U.S. producers.
The 1988 Trade Act directs the Secretary of the Treasury to analyze the  exchange rate policies of foreign countries for the purpose of considering  whether any are manipulating their currencies to gain an unfair trade  advantage and to report on international economic policies, including  exchange rates. To find that a country is manipulating the rate of exchange  between its currency and the U.S. dollar within the meaning of the Trade  Act, Treasury must determine that the country   is manipulating the exchange rate for the purpose of gaining an unfair  trade advantage or preventing effective balance of payments  adjustments, and   has a material global current account surplus and a significant bilateral  trade surplus with the United States.
If Treasury finds that a country is manipulating its currency as defined by  the Trade Act, the act requires Treasury to initiate negotiations with that  country to ensure a foreign currency exchange rate adjustment that  eliminates the unfair trade advantage. Treasury’s international policy and  exchange rate reports must meet eight reporting requirements, including  an analysis of currency market developments, an assessment of the impact  of the exchange rate of the dollar on three broad aspects of the U.S.  economy, and an analysis of capital flows. (See app. II for the exact  language of the law.)
China and Japan follow different policies for determining their currency  values. China has, since 1994, when it unified its dual exchange rate  system, pegged the value of its currency, the renminbi, to the U.S. dollar.   Chinese authorities maintain this peg by standing ready to buy and sell  renminbi in exchange for other currencies within a narrow band around the  fixed rate. When there is an excess supply of foreign exchange at this rate,  such as from surpluses in trade or net private capital flows, China’s  purchases of that excess lead to an increase in its foreign reserves. China  maintains controls on capital flows that to some extent limit the volume of  transactions in the foreign exchange market, although these controls have  not prevented substantial recent capital inflows. In contrast, the Japanese  yen is on an independent float, which means that its value relative to other  currencies is determined by demand and supply in the currency market. In  the past, Japan has carried out significant interventions in the foreign  exchange market through the sale of yen in exchange for U.S. dollars,  which has put downward pressure on the value of the yen relative to the  U.S. dollar. Nevertheless, from January 2002 through January 2005, the  yen’s value relative to the dollar increased 22 percent, from 132 yen per U.S.  dollar to 103 yen per U.S. dollar. Japan has not intervened in the foreign  exchange market since March 2004.
section_title: Treasury Has Not Found Recent Instances of Currency Manipulation
paragraphs: Although the Chinese and Japanese governments have carried out certain  economic policies and practices related to their currencies’ values that  have raised concerns among observers, Treasury has found in recent  reports that neither country meets all the legal criteria for currency  manipulation. Treasury’s overall approach to determining the presence of  currency manipulation under the terms of the Trade Act includes screening  countries and economies using a range of indicators to identify some for  closer examination, applying legally mandated criteria, and considering  multiple aspects of economic conditions and activities. Although Treasury  has cited Taiwan, Korea, and China for currency manipulation in the past, it  has found no such instances since 1994.
subsections: section_title: Stages in Treasury’s Assessment of Currency Manipulation under the 1988 Trade Act
paragraphs: Treasury’s Office of International Affairs begins its analysis of currency  manipulation by soliciting input from country desk officials responsible for  monitoring economic activity. Treasury officials stated that they use  analyses and information obtained throughout the year as the basis for  determining whether a country is manipulating its currency. Treasury  officials responsible for the currency manipulation analysis compile  available information on exchange rates and other economic conditions.  Treasury also collects information from external sources, such as private  sector experts, and meets regularly with the IMF on broad international  economic policy issues.
Treasury officials use the collected data to identify those economies  deserving closer examination. In addition to including bilateral trade  surplus and global current account surplus information in this initial  consideration, they also take into account other factors, such as changes in  currency value, capital flow conditions, and country size. (Fig. 1 presents  the ranking of economies with the largest bilateral trade surpluses with the  United States, and fig. 2 presents the ranking of those same economies  according to their current account balance as a percentage of gross  domestic product.)
Treasury does not usually scrutinize economies with large, obviously  explainable, trade balances, such as major oil-exporting nations, for  currency manipulation. On the other hand, Treasury reviews some  economies regardless of economic indicators. For instance, Treasury  consistently reviews the activities of major U.S. trading partners, such as  Japan, the European Union, and Canada. It also monitors the three  economies that it previously found to be manipulating their currencies— Taiwan, Korea, and China. Treasury selectively includes other nations in  currency manipulation assessments when it determines that economic  conditions merit.
Treasury officials stated that they make a positive determination on  currency manipulation only when all the conditions specified in the Trade  Act are satisfied. According to these officials, to reach a positive finding of  currency manipulation under the Trade Act, Treasury must find that the  economies have a material global current account surplus and a significant  bilateral trade surplus with the United States, and they are manipulating  their currency with the intent of gaining trade advantage. Treasury has  significant flexibility in determining whether countries meet these criteria.  Treasury officials told us they do not have operational definitions of a  “material” global current account surplus or a “significant” bilateral trade  surplus.
Treasury officials stated that they do not limit their analysis to the use of  the material global current account surplus and significant bilateral trade  surplus criteria listed in the Trade Act, but rather consider multiple aspects  of the economy. Treasury officials also stated that they do not use a  definitive checklist to make their determinations. Treasury officials told us  that the country-specific economic and international trade factors they  consider include  restrictions and regulations governing the use and retention of foreign  exchange and international financial flows;   movement of exchange rates, authorities’ intervention in foreign  exchange markets, and the effectiveness of that intervention;  accumulation of foreign exchange reserves;  institutional development related to banking and financial sectors;  macroeconomic indicators, including gross domestic product (GDP)  growth rates, inflation, and unemployment rates;  savings/investment balances and underlying factors;  foreign investment and international portfolio investment flow patterns;   trade regime barriers; and  external shock factors such as financial crises, oil price hikes, or natural  disasters.
The 1988 Trade Act does not require Treasury to determine if a currency is  undervalued while performing its currency manipulation assessments.  Although Treasury has in the past included observations on whether  currencies were undervalued, it no longer does so. While Treasury  officials told us they do not make an official determination on  undervaluation, in its March 2005 report to Congress (discussed below),  Treasury included measures of undervaluation among the indicators it  considers in its manipulation analysis.
Upon completion of the currency manipulation assessments, managers  within the Office of International Affairs prepare recommendations for the  approval of the Under Secretary for International Affairs. In the case of a  positive finding of currency manipulation, Treasury initiates negotiations  with officials of the economy in question, as called for by the Trade Act.
Treasury generally summarizes the results of the currency manipulation  assessments in its semiannual report to Congress, but does not explain  how it weighs the multiple economic factors it analyzes when making its  currency manipulation determinations. Over time, Treasury reports have included varying lists of factors the department considers in conducting its  currency manipulation analysis.
Congressional concern over Treasury’s currency manipulation assessments  led to a mandate in the fiscal year 2005 Consolidated Appropriations Act  requiring Treasury to report on how the statutory requirements of the 1988  Trade Act could be clarified administratively to enable currency  manipulation to be better understood by the American people and by  Congress. Treasury issued its report on March 11, 2005. In this report,  Treasury provided a high-level discussion of factors it considers when  conducting its currency manipulation assessments, including measures of  undervaluation, capital controls, and trade balances, and also described  difficulties related to rendering manipulation assessments. Treasury did  not—and was not required to—provide information on a country-specific  basis about recent currency manipulation assessments.
section_title: Treasury Has Not Found Recent Instances of Currency Manipulation under the Terms of the 1988 Trade Act
paragraphs: Since 1994, Treasury has not cited any economies for manipulating their  currency as defined by the Trade Act. Treasury officials stated they have  closely monitored recent economic behavior in China and Japan, due in  part to the rapid accumulation of foreign currency reserves in those  countries. Although Treasury has not cited China recently, it has engaged in  discussions encouraging China to move to a more flexible exchange rate  regime. Treasury did not find that Japan was manipulating its currency in  2003 and 2004. Treasury officials told us that they viewed Japan’s  interventions as a part of macroeconomic policy aimed at combating  deflation in Japan, and they expressed skepticism about the efficacy of  intervention to affect the yen’s value.
subsections: section_title: Before 1994, Treasury Cited Taiwan, Korea, and China for Currency Manipulation
paragraphs: Since the enactment of the 1988 Trade Act, Treasury has identified three  economies—Taiwan, Korea, and China—that manipulated their currencies  under the Trade Act’s terms. Treasury first cited Taiwan and Korea in 1988  and China in 1992. Taiwan was cited again in 1992. Each citation lasted for  at least two 6-month reporting periods for Taiwan and Korea, while China’s  lasted for five reporting periods.
Treasury reported evidence that the criteria for currency manipulation  under the Trade Act had been met in most of these cases. At the time of  their citations, Taiwan, Korea, and, on three occasions, China had relatively  large bilateral trade surpluses with the United States and relatively large  global current account surpluses. However, China, on two later occasions  in the mid 1990s, had either a substantially declining current account  surplus or a current account deficit when cited by Treasury for currency  manipulation.
The three economies also had other economic characteristics that Treasury  considered when it determined they were manipulating their respective  currencies. For instance, all three economies had also been rapidly  accumulating foreign exchange reserves. In addition, for both Taiwan and  Korea, Treasury found excessive restrictions on foreign exchange markets  and capital controls and evidence of heavy direct intervention in foreign  exchange markets by the authorities of Taiwan and Korea. In China’s case,  Treasury was concerned by Chinese efforts in 1991 and 1992 to frustrate  effective balance of payments adjustments through the use of a dual  exchange rate system. Treasury cited continued devaluations of the official  exchange rate and excessive controls on the market rates. (See app. III for  more details on Treasury’s previous findings of manipulation for these  three economies.)
As required by the Trade Act, Treasury entered into negotiations with  Taiwan, Korea, and China, and all three made substantial reforms to their  foreign exchange regimes. In addition, their currencies appreciated and  external trade balances declined significantly until they reached the point  at which the three were removed from the list of currency manipulators.   Treasury continues to monitor the policies and practices of these  economies for evidence of currency manipulation.
section_title: Treasury’s Recent Reporting on China and Japan
paragraphs: In recent reports Treasury has not found that either China or Japan meets  the statutory criteria for currency manipulation. Since 2001 both countries  have had periods of increasing current account surpluses and also periods  of rapid accumulation of foreign exchange reserves.
With respect to China, while Treasury did not report data on China’s global  current account surplus for the second half of 2003 or the first half of 2004,  Treasury officials stated that the surplus had not reached a material level.  In April 2004, Treasury reported that China’s overall trade surplus had been  2.6 percent of GDP in the second half of 2003. In December 2004, Treasury  reported that for the first half of 2004 China had an overall trade deficit of 1  percent of its GDP. In the same report, Treasury stated that while Chinese  foreign exchange reserves had risen sharply, the accumulation was due in  large part to steady foreign direct investment inflows and a sharp increase  in other capital inflows. (See app. IV for more details on China’s external  account development in recent years.)
Treasury officials also stated that they do not think China’s current  restrictions in foreign exchange markets and other administrative controls  on trade are comparable to conditions in the early 1990s. At that time,  important factors in Treasury’s determinations were China’s pervasive  direct controls on external trade activities and a dual exchange rate regime  with massive restrictions and controls. Since then, China has removed  restrictions on the convertibility of the renminbi for trade transactions and  substantially liberalized its trade regime, including implementing a variety  of reforms related to its accession to the World Trade Organization in 2001.
Since 1994, China has followed a policy of maintaining its currency peg to  the dollar regardless of economic conditions, according to Treasury  officials. For example, during the Asian financial crisis of the late 1990s,  China kept the renminbi’s value steady rather than depreciating it to stay  competitive with the cheaper currencies of other Asian exporting  economies. While this helped maintain the stability of its own economy and  the region, it was not consistent with a policy of keeping a cheap currency  for trade advantage, according to Treasury officials.
Despite the absence of a positive determination on currency manipulation,  Treasury has stated that China should move from its long-term fixed  exchange rate and has engaged in discussions with China to advocate a  shift to market-based exchange rate flexibility. The Chinese government  has indicated its willingness to move to a flexible exchange rate regime  after undertaking a series of preparative steps but has established no  specific timetable to complete them. To date, China has taken some steps  to reduce barriers to capital outflows, liberalize interest rates, remove  investment restrictions, and strengthen its financial infrastructure.  Treasury has provided technical assistance to help China develop market  mechanisms needed for the transition to a flexible regime, including  central bank supervision of currency risk and regulation of foreign  exchange derivative markets.
With respect to Japan, Treasury officials stated that the country’s ongoing  current account surplus reflects a long-term imbalance between savings  and investment. In the last three exchange rate reports covering 2003 and  2004, Treasury noted that Japan justified its currency market interventions  as a response to market overshooting, or excess volatility, and that such  activity did not target particular exchange rate values. Treasury officials  stated that Japan’s interventions were part of a macroeconomic policy  aimed at combating domestic deflationary pressures. In addition, Treasury  officials expressed general skepticism about the efficacy of intervention.   Japan has not intervened to prevent the appreciation of the yen since  March 2004.
section_title: Treasury Has Generally Complied with Reporting Requirements, but Its Approach to Assessing the Impact of Exchange Rates on the U.S. Economy Has Changed
paragraphs: Treasury has generally complied with the reporting requirements mandated  by the 1988 Trade Act (see table 1), although its discussion of U.S.  economic impacts has become less specific over time. Treasury exchange  rate reports have consistently included information responding to four  requirements: (1) analysis of currency market developments, (2)  evaluations of underlying conditions in the United States and other  economies, (3) descriptions of currency market interventions, and (4)  analysis of capital flows. Treasury can respond to a fifth reporting  requirement, recommendations for changes necessary to attain a  sustainable current account balance, at its discretion. A sixth requirement,  reporting outcomes of negotiations, is only relevant when Treasury makes  a finding for currency manipulation under section 3004 of the act, and  Treasury has complied with this requirement when applicable. Treasury did  not include updates for the seventh requirement—U.S.–IMF  consultations—in six reports from 2001 to 2004. According to Treasury  officials, by this time summaries and complete reports of IMF  consultations with the United States had become publicly available on the  Internet, and reporting on these consultations was unnecessary. The  December 2004 report included an Internet link to IMF consultation  information.
Treasury has over time changed its approach for complying with its  remaining requirement—an assessment of the impact of the exchange rate  on the U.S. economy. According to Treasury officials and our analysis of  the exchange rate reports, Treasury’s view of the role of exchange rates on  the U.S. balance of payments and the economy in general has changed  since 1988. Treasury’s reports generally discussed at least some elements of  the impact-reporting requirement from the late 1980s through the 1990s.  From 1988 into the early 1990’s, Treasury’s reports generally discussed  exchange rate effects on U.S. external balances and economic growth.  From 1994 through 1999 and into 2000, Treasury reports generally  advocated a “strong dollar” policy. Reports in 1994 through 1997 discussed  specific U.S. benefits of such a policy, such as lower inflation and higher  investment and economic growth.
Treasury’s impact-related analysis after the 1990’s cited the importance of  broader macroeconomic and structural factors behind global trade  imbalances. Treasury viewed exchange rates as one of several interacting  economic variables needing attention to address global imbalances. For  example, in the October 2003 and April 2004 reports, Treasury reported that  the current account deficit represented the gap between savings and  investment, and its sustainability depended on the attractiveness of U.S.  capital markets to foreign investors. Its analysis also emphasized the  importance for U.S economic interests of strong growth of U.S. trading  partners. Treasury’s most recent report in December 2004 did identify  exchange rate flexibility for certain Asian economies as an area of policy  the administration is following to reduce global imbalances.
Given its broad approach to impact-related analysis, Treasury’s semiannual  reports do not contain discrete examinations of the effect on the U.S.  economy of changes in the dollar’s value. Thus, Treasury’s reports do not  specifically address the impact of the dollar on aspects of economic  activity listed in the 1988 Trade Act, including production, employment,  and global industrial competition. Treasury states that it does consider the  impact of the exchange rate on these variables and that their broader  approach meets the intent of the impact reporting requirements set forth in  the 1988 Trade Act.
section_title: Estimates of the Undervaluation of China’s Currency Vary Widely, and Views on Policy Steps Differ
paragraphs: Many experts maintain that China’s currency is significantly undervalued,  while some believe that undervaluation is not substantial or that  calculating reliable estimates is not possible. Even among experts who  believe that China’s currency is undervalued, there is no consensus on how  and when China should move to a more flexible exchange rate regime and  whether or not capital account liberalization, including, for example, lifting  restrictions on outward flows of Chinese capital, should be a part of that  process.
subsections: section_title: Many Experts Conclude China’s Currency is Undervalued, but Methodological Challenges Cause Differences
paragraphs: Most of the estimates we reviewed indicated that China’s currency is  undervalued to some extent, with some experts suggesting substantial  undervaluation and others slight misalignment. While there is no consensus  methodology for determining whether a country’s currency is undervalued,  experts have applied a number of commonly used approaches to the case  of China. (See app. V for details of the various methodologies and their  limitations.)  These approaches generally involve determining an  equilibrium exchange rate, broadly defined as the exchange rate that is  consistent with a country’s economic fundamentals, when the country is  operating at full employment and in a free market. As table 2 illustrates,  estimates of renminbi undervaluation range from none to over 50 percent.  Some of these estimates are rough calculations based on “rule-of-thumb”  assumptions while others are based on formal models. In addition, some of  these estimates may be most appropriately categorized as measures of  near-term undervaluation or short-term pressure indicators. Moreover, the  margins of error for these estimates are generally unknown.
The significant variation in estimates of remninbi undervaluation can be  attributed in part to different methodological approaches, but similar  methodologies can also yield differences. The absolute version of the  Purchasing Power Parity (PPP) methodology, which determines the  exchange rate at which identical goods would trade at the same price in  both countries, produces estimates that generally show the renminbi is  considerably undervalued. The External Balance approach is based on  calculating an exchange rate that would result in a country achieving a  sustainable balance in its external accounts, such as its current account  balance or its trade balance. In the studies we reviewed, this approach  generally produced estimates of currency undervaluation for China from 4  to 25 percent, with one estimate of 40 percent. Moreover, there are often  significant differences in estimates even when similar methodologies are  used. For example, experts who use the Behavioral Equilibrium Exchange  Rate (BEER) approach, which uses econometric relationships between  exchange rates and other economic variables to estimate an equilibrium  exchange rate, have found renminbi undervaluation ranging from 11 to 47  percent.
Some experts doubt that equilibrium exchange rates can be estimated and  thus believe that whether a currency is under- or overvalued cannot be  reliably determined. Treasury officials and some other experts we spoke  with stated that estimating equilibrium exchange rates is especially  challenging for developing economies with rapidly changing economic  structures, such as China. According to Treasury, the determination of  under- or overvaluation requires analysis of key economic variables, the  measures for which are subject to considerable uncertainty in China.  Moreover, determining an equilibrium exchange rate is especially difficult  for China because China restricts the outflow of funds from the country.  (See app. IV for a discussion of China’s capital controls.)
Some observers and analysts view China’s growing foreign exchange  reserves  as evidence that the renminbi is undervalued. China’s foreign  exchange reserves increased by $399 billion dollars—185 percent—from  the end of 2001 to the end of 2004. These observers maintain that the  reserves, which partly reflect China’s surpluses in global trade and foreign  direct investment (FDI), are evidence that the value of the renminbi is too  low relative to the demand for renminbi-denominated goods, services, and  other investments; as a result, China must purchase large amounts of  dollars to keep the renminbi’s value from increasing beyond its U.S. dollar  peg.
Using reserve accumulations as evidence of a mismatch between the  current value of the renminbi and its long-run equilibrium value has  limitations, however, according to several analysts. China’s foreign reserve  accumulation has several components:  the current account balance, FDI  net inflows, non-FDI net inflows (which include portfolio investment such  as stocks and other investments), and undocumented capital—referred to  as errors and omissions. China’s current account surpluses and FDI  inflows were the primary components of the $117 billion increase in its  reserves in 2003, accounting together for about 80 percent. Net non-FDI  inflows and errors and omissions accounted for about 20 percent of the  reserve increase. (See further details in app. IV.)
section_title: Views on Policy Steps for China Differ
paragraphs: Treasury has urged China to move to a market-based flexible exchange rate  and take steps to remove restrictions on capital flows. There is debate  regarding steps and timing on both issues. With respect to whether and  when China should change its exchange rate policy, there are varying views  even among experts who believe the currency is undervalued. Some  experts have recommended that China immediately revalue the renminbi,  either relative to the U.S. dollar or to a broader group of currencies. Others  have suggested that China should move to a more flexible system—with a  freely floating exchange rate being the most flexible. Analysts have  identified potential advantages of such policy changes for China and also  for other countries. Analysts have also identified a number of challenges  for China. For example, some experts have cautioned that there could be  economic costs to China if the monetary authorities revalue the currency  and guess wrong about how large the revaluation should be. They have  stated that a small revaluation could encourage further speculative capital  flows into the country in anticipation of a further revaluation, which would  increase reserves. Some have also expressed concern that a large  appreciation in the renminbi’s value could unnecessarily slow down the  Chinese economy and worsen labor conditions in the country, which has  high unemployment in certain regions.
There are also varying views on changes in China’s policies regarding  restrictions on capital flows. China currently restricts outward flows of  Chinese capital for foreign direct investment and purchases of securities  abroad, although it eased some restrictions in 2004. (See app. IV for  additional information on these restrictions.) A number of advocates of  greater exchange rate flexibility maintain that China is not ready for  significant capital account liberalization and that the government should  maintain some capital controls after moving to a more flexible exchange  rate. One reason cited is that liberalization would expose China’s financial  sector to risk if, for example, banks in China that are not financially strong  experienced erosion of their deposit base from investors switching funds  offshore.
Several policy options advocated for China’s currency involve a gradual or  multistep process, which proponents maintain could minimize the  potential for adverse effects of revaluation. One expert, for example, has  advocated a two-stage currency reform process for China. The first stage  would entail pegging the renminbi to a group of currencies, including the  dollar, rather than pegging to the dollar alone; a 15 to 25 percent  revaluation; and setting a 5 to 7 percent band for renminbi fluctuation  against the new currency basket. The second step would be a significant  liberalization of capital outflows and adoption of a managed float. The second step would occur following adequate strengthening of China’s  banking system.
section_title: The U.S. Impact of a Renminbi Revaluation Would Depend on Multiple Factors
paragraphs: A revaluation of the renminbi could have implications for various aspects  of the U.S. economy—with both costs and benefits—although the impacts  are hard to predict. First, a higher-valued renminbi would make Chinese  exports to the United States more expensive and U.S. exports to China  cheaper—with the extent depending on several factors—which could  increase U.S. production and employment in certain sectors. Some groups  could be negatively affected by a higher-valued renminbi, including U.S.  producers who use imports from China in their own production and would  face higher prices and costs of production. Consumers in the United States  could also face higher prices. Finally, an upward revaluation of the  renminbi could also affect flows of capital to the United States from China,  which have in recent years accounted for a significant source of financing  of the U.S. trade deficit.
subsections: section_title: Several Factors Could Significantly Influence the Impact of China’s Currency on the U.S. Economy
paragraphs: Although a revaluation of the renminbi relative to the dollar would tend to  make U.S. exports to China cheaper and U.S. imports from China more  expensive, just how much more expensive China’s imports would  become—and the impact on the U.S. trade deficit, production, and  employment—would ultimately depend on several factors. Some key  factors include the following:  How much of the exchange rate appreciation is “passed-through” to  higher prices for U.S. purchasers. Experience with other nations  generally shows that pass-through is less than complete, particularly in  the short term, because contracts for exports to the United States may  be written in dollars. Longer term, the extent of pass-through depends  on factors such as the extent to which Chinese exports to the United  States are made up of inputs from other countries (since these would  become cheaper with a stronger renminbi), and the extent to which  Chinese exporters reduce their costs or profit margins.
The extent of the U.S. market response to the higher prices. In some  markets, U.S. purchasers may continue to buy nearly the same volume  of Chinese imports at the higher prices, while in others U.S. purchasers  may decide to sharply reduce their purchases. The less responsive the  overall U.S. demand is to price changes of Chinese imports, the less  changes in the renminbi-dollar exchange rate will affect the U.S. trade  balance, production, or employment. The same is true on the other  side of the market; if Chinese demand for U.S. exports is unresponsive  to the lower prices of U.S. goods, Chinese buyers will not buy much  more in the short run even if prices of U.S. exports have fallen.
The extent to which products now being manufactured in China  would be produced in other countries rather than in the United States.  It is probable that goods from other countries with low labor costs  would replace a portion of Chinese exports to the United States if the  renminbi were to increase in value, thus reducing the impact on the U.S.  economy. Specifically, some experts believe that decreased imports  from China would be largely replaced by slightly higher-priced imports  from other low-income countries such as Sri Lanka, Vietnam,  Bangladesh, and Pakistan, among others, instead of being manufactured  in the United States.
Whether other countries follow China and adjust their policies. Some  analysts contend that the renminbi’s peg to the dollar induces other East  Asian countries to intervene in currency markets to keep their  currencies weak against the dollar so that they can remain competitive  with China. Some believe that a revaluation by China might encourage  other countries to change their exchange rate policies as well. This  would magnify the impact of a revaluation on the United States.
The time period necessary for these adjustments to take place. While a  currency appreciation has some immediate effects, the impacts on the  trade statistics, production decisions, and employment generally take a  longer time. In the short term, the U.S. trade deficit may increase as it  takes more dollars to buy the same amount of Chinese products. As the  higher prices are factored into new purchasing decisions, the  appreciation would lead to effects on U.S. production and employment  that could occur over a period of months or years. (See app. VI for an additional discussion of these and other factors  affecting the extent of revaluation impacts.)
section_title: A Renminbi Revaluation Could Have Both Costs and Benefits for the U.S. Economy
paragraphs: Changes in the value of a currency like the renminbi could affect the U.S.  economy in a variety of ways, and assessing the effects is complex. For  example, an increase in the renminbi’s value could affect the mix of jobs in  certain sectors, benefiting those sectors that compete directly with foreign  products. However, in terms of employment, many experts believe that a  rise in the value of the renminbi relative to the dollar would be unlikely to  have much, if any, effect on aggregate employment in the United States.  This is because the overall level of U.S. jobs is generally viewed as being  largely determined by factors such as the domestic labor supply and  broader macroeconomic factors such as U.S. monetary policy. In addition,  an increase in the value of the renminbi could have other types of impacts  that affect the economy more broadly, such as influencing the prices of  goods and interest rates.
Examples of groups that would be expected to benefit from an upward  revaluation of the renminbi include:  U.S. firms and workers exporting to China—U.S. exports would  become cheaper for Chinese consumers.
U.S. firms and workers producing goods that compete with Chinese  imports—Chinese imports would become more expensive for U.S.  consumers.
Low-wage countries other than China—Their exports could displace  Chinese exports to the United States.
U.S. investors in China—The value of assets in China would increase.
Examples of groups that would be expected to experience some losses  from an upward revaluation of the renminbi include:  U.S. consumers—Imports from China would cost more.
Certain U.S. producers—Firms that import Chinese components in the  production of final goods would pay more for those components.
Borrowers in U.S. capital markets—A possible decrease in capital  flows from China could increase pressure on U.S. interest rates.
Multinational firms in China—The cost of production in dollars would  increase and possibly raise the prices of final goods shipped to the  United States.
section_title: Analysis of Impacts of a Renminbi Revaluation on the U.S. Deficit and Manufacturing Sector Illustrates the Importance of Methodological Assumptions
paragraphs: Discussions of a revaluation of the renminbi have tended to focus on the  outcome for workers in the U.S. manufacturing sector because U.S.  employment in this sector has shrunk considerably in recent years and is  believed to be sensitive to international trade. Predicting the  manufacturing sector production and employment effects of a change in  the renminbi’s value is complex and is related to changes in trade flows.  Therefore, some analysts have used estimates of changes in the U.S. trade  deficit to estimate potential manufacturing production and employment  effects, at least over the short run, although such linkages involve further  uncertainties.
The following exercise illustrates how possible impacts of a renminbi  revaluation on the U.S. trade deficit could vary under different  assumptions. The estimates use as a starting point an assumption for the  relationship between the overall exchange rate of the dollar and the U.S.  trade deficit from the IMF’s April 2004 World Economic Outlook and then  illustrate the impact of additional assumptions regarding exchange rate  pass-through, import displacement, and follow-on exchange rate  adjustments (see table 3).
These assumptions are not analytically precise, and other researchers have  used different assumptions.
As shown in the table, with a hypothetical upward revaluation of 20  percent, the estimates for trade deficit reduction due to a revaluation of the  renminbi under these assumptions range from $3.3 billion to $13.3 billion,  depending on pass-through, the displacement effect, and follow-on  exchange rate adjustments. Estimates outside of the range of estimates  provided here could be obtained using different assumptions. These  estimates could change further by accounting directly for other factors  such as the sensitivity of U.S. demand to price changes of Chinese imports.
Some analyses have drawn conclusions about the impact of exchange rate  changes on U.S. manufacturing jobs by using additional assumptions to  those employed above. For example, one analysis used the assumption that  a $1 billion increase in the U.S. trade deficit would lead to a decline in U.S.  manufacturing jobs of about 15,000. Applying such a value to estimates of  a 20 percent renminbi revaluation, under the assumptions shown in  scenario 3, would lead to estimates of manufacturing sector job impacts of  about 49,800 jobs. Under scenario 4, with the additional assumption of  follow-on exchange rate adjustments if the renminbi were revalued, the  manufacturing sector job impact estimate would be 199,000. These  analyses have limitations. Researchers have observed that trade affects the  demand for manufacturing labor in complex ways, particularly with  respect to imported goods and components. Moreover, as noted above, the  long-run level of employment in the economy is generally viewed as being  determined by demographic and broader macroeconomic factors such as  monetary policy. Thus, to the extent there are manufacturing sector job  impacts of a renminbi revaluation, they may be offset by job losses in other  sectors of the economy.
section_title: An Upward Renminbi Revaluation Could Have Implications for U.S. Capital Flows
paragraphs: Capital flows must also be considered in an assessment of the implications  of a renminbi revaluation. The U.S. bilateral trade deficit with China—and  its maintenance of a fixed exchange rate to the dollar—has been  accompanied by an inflow of funds into U.S. capital markets from China.   This has occurred during a period of an overall rise in inflows of foreign  capital accompanying increasing U.S. trade and current account deficits. To  the extent that a revaluation of the renminbi would lead to a decrease in the  U.S. global current account deficit, it would also be associated with lower  capital inflows. Such capital inflows—U.S. borrowing from foreign  sources—can benefit the United States by lowering interest rates and  stimulating investment and consumption. However, U.S. interest payments  on this foreign-held debt are sent abroad. In addition, some analysts  believe that U.S. dependence on inflows of foreign capital carries risk  because of the potential for foreign investors to decide to hold or purchase  less U.S. debt. The potential for, and consequences of, a widespread  withdrawal of investment funds from U.S. markets has recently been  debated. While some analysts believe that the effects of a foreign  withdrawal from U.S. financial markets—or a reduction in foreign  purchases of U.S. debt—would have limited effects over the long run, some  acknowledge that short-run disruptions, such as the loss of value of assets  and higher interest rates, could be significant.
According to Treasury data, about 44 percent of the total value of  outstanding U.S. Treasury securities held by the public is held by  foreigners. At the end of 2004, China held 4.2 percent of the total holdings  of outstanding U.S. Treasury securities, which is about 10 percent of these  securities held by foreigners (see fig. 3). By far the largest holder of U.S.  Treasury securities is Japan, which holds 16.6 percent. The United  Kingdom, with 3.0 percent, is third behind China.
As figure 4 illustrates, China was one of the largest purchasers of U.S.  Treasury securities from 2001 to 2004—$95.4 billion, compared to $367.4  and $168.1 billion for Japan and the United Kingdom, respectively. Like  other foreign central banks, China’s central bank has chosen to purchase  large quantities of U.S. Treasury securities with renminbi in part because it  can buy and sell them quickly with minimal market impact. Figure 4 also  shows that, in recent years, China has been a strong purchaser of other  types of U.S. securities, especially agency bonds, according to data from  the Treasury International Capital (TIC) reporting system. Between 2001  and 2004 China purchased on net about $243.5 billion in total U.S.  securities, behind the United Kingdom and Japan. (See app. VII for more  data on net purchases of U.S. Treasury securities by China and other  countries).
section_title: Observations
paragraphs: While we make no recommendations in this report, we believe that our  analysis provides important insights into the debate over exchange rates  and U.S. government assessments of currency manipulation. The debate  involves several issues that are related, but distinct. The first is currency  manipulation. Assessing currency manipulation under the terms of U.S. law  is complex and involves both country-specific and broader international  economic factors. A second issue is undervaluation of currencies.
Countries with undervalued currencies are presumed to obtain trade  benefits from the undervaluation and therefore are often assumed to be  manipulating their currencies to maintain these benefits. Many experts  tend to focus on undervaluation—which Treasury is not required to  determine. A third issue is the policy response that is expected from  nations that are the focus of the debate. For example, experts who believe  that China’s currency is undervalued have varying views about what action  China should take, including whether certain policy options entail risks to  China’s economy. In this report, we have tried to keep these issues distinct,  because we believe it aids in clarifying the debate.
The level of concern over exchange rate issues—especially with respect to  China--is not surprising given the continuing growth of the U.S. trade  deficit, the rapid growth of China’s exports to the United States, and the  recent depreciation of the dollar against several major currencies. In  addition, as trade agreements reduce many of the industry-specific barriers  to world trade, there has been a shift in attention toward the  macroeconomic aspects of trade, which include exchange rates as well as  national savings and investment rates. News that China’s trade and current  account surpluses were higher than expected in 2004 increases the need for  good information on factors affecting international trade and financial  flows, especially with respect to China, and the implications of these flows  for the United States. Congress recently required Treasury to provide  information on aspects of its reporting under the 1988 Trade Act, to  facilitate better understanding by the American people and Congress.  Treasury’s March 2005 report in response to this mandate provided a high- level discussion of key factors Treasury considers in its currency  manipulation assessments and sheds light on the complexities of the  assessments but did not provide—and was not required to provide-- country-specific information about Treasury’s recent assessments. Since  then, Members of Congress have continued to propose legislation to  address China currency issues. We believe that the analysis in this report  provides a basis for further discussion of currency manipulation concerns.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft report to the Department of the Treasury. Treasury  provided written comments, which are reprinted in appendix VIII. Treasury  stated that the report is generally thoughtful and hopes that it will  contribute to increased understanding of the complex issues covered in its  exchange rate reports. Treasury also emphasized several aspects of its  exchange rate assessments and its reports. For example, with respect to  reporting on U.S. economic impacts, Treasury stated that when conducting  its analysis it does consider how the exchange rate of the dollar affects  areas such as the sustainability of the current account deficit, production,  and employment. Treasury stated that it believes it is often more helpful to  look at underlying developments that affect exchange rates and other  macroeconomic conditions rather than to achieve a false sense of precision  by isolating the exchange rate in the analysis. Treasury also provided  technical comments, which we incorporated in the report as appropriate.
As agreed with your office, unless you publicly announce its contents  earlier, we plan no further distribution of this report until 30 days from the  date of its issuance. At that time, we will send copies of this report to  interested congressional committees, the Secretary of the Treasury, and  other interested parties. We will make copies available to others upon  request. In addition, the report will be available at no charge on the GAO  Web site at http://www.gao.gov.
If you or your staffs have any questions concerning this report, please  contact me at (202) 512-4128 or at yagerl@gao.gov. Other GAO contacts and  staff acknowledgments are listed in appendix IX.
section_title: Objectives, Scope, and Methodology
paragraphs: The Chairs of the Senate Committee on Small Business and  Entrepreneurship and the House Committee on Small Business asked us to  review the Department of the Treasury’s efforts to fulfill its legal  obligations under the 1988 Trade Act and related issues. We examined (1)  the process Treasury uses to conduct its assessments of currency  manipulation and the results of recent assessments, particularly with  respect to China and Japan; (2) the extent to which Treasury has met the  1988 Trade Act reporting requirements; (3) experts’ views on whether or by  how much China’s currency is undervalued; and (4) the implications of a  revalued Chinese currency for the United States.
To determine the process Treasury uses to conduct its currency  manipulation assessments and the results of recent assessments,  particularly with respect to China and Japan, we reviewed the legal  provisions of the 1988 Trade Act requiring Treasury to analyze foreign  currency manipulation, and the act’s legislative history. We also  interviewed responsible Treasury officials to better understand the  assessment process. In addition, we reviewed Treasury exchange rate  report findings on whether other countries are manipulating their  currencies. Specifically, we examined the conditions cited in the Treasury  reports that led to determination of currency manipulations for Taiwan,  Korea, and China from 1988 to 1994. We also examined the changes in the  economies’ conditions that led to removals of citations or, in some cases,  subsequent citations for these economies; and we interviewed Treasury  officials to understand Treasury’s reasoning behind its findings for China  and Japan. We interviewed IMF officials to obtain information on  Treasury’s consultive process with IMF. To gain a broader perspective on  the economic conditions of China and Japan, we examined recent domestic  and international economic data and information on those two countries’  current exchange rate regimes and practices.
To determine the extent of Treasury’s compliance with reporting  requirements, we reviewed all of Treasury’s exchange rate reports since  1988. We analyzed the reports and categorized our assessment of Treasury’s  compliance for each of the eight reporting requirements. In addition, we  interviewed Treasury officials to discuss Treasury’s recent efforts to  address the requirement to assess the impact of the exchange rates on the  U.S. economy. Finally, for verification, we compared statements of  Treasury officials with the exchange rate reports.
To obtain experts’ views on whether or by how much China’s currency is  undervalued and the value’s implications for the United States, we  identified studies and views of economists with expertise in the area that  had been cited in congressional testimony and in other prominent policy  forums, reviewed those and related studies, and interviewed a selection of  experts spanning the spectrum of opinions on Chinese currency valuation.   GAO economists reviewed these research papers and testimonies solely to  describe the analyses and differences among them. The inclusion of the  results of these studies is to show that estimates of undervaluation for  China vary widely and that the analysis of the impact on the U.S. economy  is complex; their inclusion does not imply that we deem them definitive. To  describe and analyze country economic data and indicators used by many  of these experts, we used data from the International Monetary Fund’s  (IMF) World Economic Outlook and other sources, including the Bureau of  Labor Statistics and the Federal Reserve Board. We also obtained foreign  exchange reserve data from Global Insight and data on Japanese  interventions for the 2000 to 2004 period from Japan’s Ministry of Finance.  We used U.S. trade statistics compiled by the Department of Commerce’s  statistical agencies to analyze the composition and trends in the U.S.  merchandise trade deficit. We note that there are significant differences  between U.S.–China bilateral trade data reported by the United States and  that reported by China. We did not conduct an evaluation of these  differences, which others have attributed to general differences in how  imports and exports are valued, how the United States and China record  imports and exports shipped through Hong Kong, and the quality of  Chinese statistics. The reliability of Chinese statistics may also impact  IMF’s statistics because much of the data used by IMF is self-reported by  member countries. We determined that these data are sufficiently reliable  for our purposes of presenting and analyzing trends in trade patterns and  basic economic trends for China.
In addition, to describe a range of views on how China might move to an  alternative exchange rate value or regime, we identified several  representative policy suggestions from the studies we reviewed and the  experts we consulted regarding assessments of whether China’s currency is  undervalued.
To describe the implications of a revalued Chinese currency for the United  States, we identified and reviewed studies that had been cited in  congressional testimony and other policy forums, and by research  institutions including the IMF. We discussed these studies with several  experts spanning a range of views. To illustrate how estimates of the effects  of exchange rates on U.S. manufacturing jobs depend on key assumptions,  we identified assumptions from studies we reviewed and made illustrative  calculations using different assumptions. These assumptions are not  analytically precise, and we did not present particular estimates as being  superior to others. Alternative combinations of assumptions or alternative  assumptions can yield impact estimates outside the ranges presented in our  analysis. The hypothetical percentages of undervaluation and assumptions  are for illustrative purposes; the illustration does not imply that GAO has  taken a position on the value of China’s currency or its actual impact on the  U.S. economy.
We also obtained data on hourly compensation costs from the Bureau of  Labor Statistics to provide background for our discussion of the role of  labor costs in international competitiveness. We determined that the data  are sufficiently reliable for the purpose of illustrating substantial variations  in labor costs across countries. However, the data are partially estimated  and thus the statistics should not be considered precise measures of  comparative costs and are subject to revision. For some foreign economies,  the estimates are based on less than one year of data. There may also be  variations in the definitions, scope, coverage, and methods used in  compiling the data and in its presentation. These include the treatment of  the financing of social security and the systems of taxes or subsidies.
In addition, we calculated the portion of U.S. Treasury bills and corporate  equities held by the two countries using the U.S. Treasury International  Capital Reporting System (TIC) and the Federal Reserve Board’s Flow of  Funds data to present information on China and Japan’s weight in U.S.  capital markets. We used these data because they constitute the only data  available for these transactions, but we note in presenting the information  that because of the way the data are collected there is a bias toward  overcounting flows to countries that are major financial centers and  toward undercounting flows to other countries. As a result, excessive  foreign holdings may be attributed to some countries that are major  custodial centers, such as the United Kingdom, Switzerland, Belgium, and  Luxembourg. Moreover, because the Bureau of Economic Analysis adjusts  the TIC data somewhat before it reaches the Federal Reserve Board and  because of timing issues, the data on total foreign holdings from the two  sources have slight but insignificant differences. We determined that the  data are sufficiently reliable for our purpose of illustrating whether China  and Japan are major holders or purchasers of U.S. securities. We note,  however, that as a result of the limitations identified, GAO calculations of  the percentage of U.S. securities held by Japan and China based on the  primary TIC and Federal Reserve data should be viewed as  approximations.
In addition to the bias detailed above, the raw transactions data (net  purchases) documented in figure 5 and the associated tables in appendix VI  may contain errors due to the manner in which repurchase and securities  lending transactions are recorded within the TIC system. Because these  transactions are known to be substantial, producers of the data note that  this could produce significantly inaccurate data. Moreover, because these  data include commissions and taxes associated with each transaction, the  result is a slight overestimation of net purchases. These data are also  revised periodically. The TIC system is the official source of this data, it is  widely used by outside experts, and the limitations are not particular to any  one country. Therefore we determined that they were sufficiently reliable  for a comparison of net purchases of U.S. securities by China with other  major purchasers and generally assessing the role of China in U.S. financial  markets. However, the data must be interpreted with caution because  recent transaction data may have overstated net foreign purchases of U.S.  securities, especially debt instruments.
To verify the reliability of most data sources, we performed several checks  to test the data’s accuracy or we reviewed limitations, wherever possible.  We reviewed agency or company documents related to their quality control  efforts and conferred with GAO’s statistical expert for relevant data. For  several sources, we tracked secondary data to the source data and  reviewed other experts’ uses and judgments of that data. For several  sources, we compared the raw data, or the descriptive statistics computed  using the data, with equivalent statistics from other sources. We  determined that the data sources we used were sufficiently reliable for the  purposes of this audit. Although in many cases there were limitations, they  are generally minor in the context of this report. We were unable to  conduct a review of the Japanese Ministry of Finance intervention data.  However, given that the Ministry of Finance is the primary and official  source of these data and they are widely used by outside experts and  policymakers, including the Federal Reserve Bank of New York, we have  included some of the data in this report for illustrative purposes.
We conducted our work from September 2003 through February 2005 in  accordance with generally accepted government auditing standards.
section_title: Omnibus Trade and Competitiveness Act of 1988
paragraphs: Omnibus Trade and Competitiveness Act of 1988 (Pub. L. No. 100-418, §§  3004(b) and 3005)
Sec. 3004. International Negotiations on Exchange Rate and Economic  Policies. (b) Bilateral Negotiations—The Secretary of the Treasury shall analyze on  an annual basis the exchange rate policies of foreign countries, in  consultation with the International Monetary Fund, and consider whether  countries manipulate the rate of exchange between their currency and the  United States dollar for purposes of preventing effective balance of  payments adjustments or gaining unfair competitive advantage in  international trade. If the Secretary considers that such manipulation is  occurring with respect to countries that (1) have material global current  account surpluses; and (2) have significant bilateral trade surpluses with  the United States, the Secretary of the Treasury shall take action to initiate  negotiations with such foreign countries on an expedited basis, in the  International Monetary Fund or bilaterally, for the purpose of ensuring that  such countries regularly and promptly adjust the rate of exchange between  their currencies and the United States dollar to permit effective balance of  payments adjustments and to eliminate the unfair advantage. The Secretary  shall not be required to initiate negotiations in cases where such  negotiations would have a serious detrimental impact on vital national  economic and security interests; in such cases, the Secretary shall inform  the chairman and the ranking minority member of the Committee on  Banking, Housing, and Urban Affairs of the Senate and of the Committee on  Banking, Finance and Urban Affairs of the House of Representatives of his  determination.
Sec. 3005. Reporting Requirements. (a) Reports Required—In furtherance of the purpose of this title, the  Secretary, after consultation with the Chairman of the Board, shall submit  to the Committee on Banking, Finance and Urban Affairs of the House of  Representatives and the Committee on Banking, Housing, and Urban  Affairs of the Senate, on or before October 15 each year, a written report on  international economic policy, including exchange rate policy. The  Secretary shall provide a written update of developments six months after  the initial report. In addition, the Secretary shall appear, if requested,  before both committees to provide testimony on these reports. (b) Contents of Report—Each report submitted under subsection (a) shall  contain (1) an analysis of currency market developments and the relationship  between the United States dollar and the currencies of our major trade  competitors; (2) an evaluation of the factors in the United States and other economies  that underline conditions in the currency markets, including developments  in bilateral trade and capital flows; (3) a description of currency intervention or other actions undertaken to  adjust the actual exchange rate of the dollar; (4) an assessment of the impact of the exchange rate of the United States  dollar on (A) the ability of the United States to maintain a more appropriate and  sustainable balance in its current account and merchandise trade account; (B) production, employment, and noninflationary growth in the United  States; (C) the international competitive performance of United States industries  and the external indebtedness of the United States; (5) recommendations for any changes necessary in United States economic  policy to attain a more appropriate and sustainable balance in the current  account; (6) the results of negotiations conducted pursuant to section 3004; (7) key issues in United States policies arising from the most recent  consultation requested by the International Monetary Fund under article IV  of the Fund’s Articles of Agreement; and (8) a report on the size and composition of international capital flows, and  the factors contributing to such flows, including, where possible, an  assessment of the impact of such flows on exchange rates and trade flows.
section_title: Conditions that Led to the Determination of Currency Manipulation and Removal
paragraphs: At different times during the period from 1988 to 1994, Treasury found that  Taiwan, Korea, and China manipulated their currencies under the terms of  the 1988 Trade Act. The conditions leading to their first citations and the  changes in conditions that later led to their removal are listed below.
section_title: Overview of China and Japan’s Recent Economic Conditions
paragraphs: This appendix presents an overview of recent economic conditions for  China and Japan that are relevant to exchange rate policies. These include  economic growth, external account balances, foreign exchange reserves,  exchange rate movements, currency exchange rate regimes, and direct  interventions in foreign exchange markets by national authorities.
subsections: section_title: China
subsections: section_title: Economic Growth and Trade Balance
paragraphs: China has experienced high rates of economic growth in recent years.  According to IMF- reported country data, the Chinese economy grew at  annual rates of 7.1 percent to 9.6 percent during 1996 to 2004 (see fig. 5).  Although economists have questioned the quality of Chinese national  account statistics,  there is a general consensus that the Chinese economy  has grown rapidly during the past 2 years. In fact, the Chinese government  has implemented policies since mid-2003 to slow economic growth because  of concerns about overheating the economy.
China’s economic growth has been accompanied by a large total trade  volume, which was 59 percent of gross domestic product (GDP) in 2003  and 73 percent of GDP according to preliminary 2004 data. The large trade  volume has been accompanied by China’s consistently positive current  account balance. While China’s current account surplus declined from  around 3.3 percent of (GDP) in 1998 to less than 2 percent in 1999 to 2001,  it rose to 2.8 percent in 2002 after accession to the World Trade  Organization and then to 3.2 percent in 2003. Preliminary data for 2004  indicated a surplus of 4.2 percent. (See fig. 6.)
The Chinese government has rapidly accumulated foreign exchange  reserves in recent years, which some observers have seen as evidence of  currency undervaluation and manipulation. China’s total foreign exchange  reserves (excluding gold and other assets at the IMF) reached $614.5 billion  by the end of 2004. As figure 7 shows, this represents approximately three  times the level of China’s reserves in 2001.
Changes in China’s foreign exchange reserves have several components:   changes in the current account balance, changes in net flows of foreign  direct investment (FDI), changes in net non-FDI flows, and undocumented  capital—or errors and omissions. Both China’s current account surplus and  net FDI inflows were major components of the reserve increases from 2001  through 2003. (See table 4.) In addition, changes in non-FDI net inflows  (defined as portfolio investment and other investment) and errors and  omissions have also been important to the reserve increases. These  components had been strongly negative—meaning significantly greater  outflows than inflows—in 1999 and 2000, which had worked to dampen  China’s reserve accumulation. However, the balance changed and in 2003  non-FDI flows and errors and omissions were strongly positive. One reason  for the increase in these inflows into China is large speculative inflows that  may be driven by expectations of an upward revaluation of the renminbi.
The basic relationship between China’s current account balance and capital  and financial account flows is also depicted in table 4. For 2003, the last  year for which complete data is available, China had a current account  surplus of $45.9 billion accompanied by a capital account surplus of $52.8  billion. Maintaining large surpluses in both current and capital accounts is  relatively unusual compared to other countries. For example, the United  States has had in recent years a current account deficit financed by a  capital account surplus; that is, the United States borrows from foreigners  to purchase goods. Japan, in contrast, has generally had in recent years a  current account surplus and a deficit in its capital account, including a net  outflow of FDI. China’s net capital inflow in 2003 was predominantly in the  form of direct investment. This is in part because China has a relatively  open door policy on FDI but restricts other forms of foreign investment.
subsections: section_title: China’s Exchange Rate
paragraphs: China has, since the fall of 1994, had a de facto fixed exchange rate regime,  as classified by the IMF, with its exchange rate pegged to the dollar (see fig.  8). Prior to that point, China maintained a dual exchange rate regime with  an official fixed rate and market-negotiated rates. The official fixed rate  was devalued several times before it was unified with the prevailing market  rate in early 1994, and the exchange rate regime was officially changed to a  managed float. The renminbi began to appreciate slightly (to 8.3 renminbi  per U.S. dollar) soon after the unification, mainly due to export growth  caused by a wave of foreign direct investment. Chinese authorities decided  to hold the rate within a small band of 0.25 percent. By 1998, the exchange  rate had been allowed to appreciate slightly to 8.28 renminbi per U.S.  dollar, with a narrow band, where it has stayed until the present.
Between 1986 and 1994, China had a dual exchange rate regime in which  the official fixed exchange rate coexisted with the market-negotiated rates  in Foreign Exchange Adjustment Centers (also called swap centers). The  official rate applied to trade transactions and other activities that were  controlled by state planning. Market rates, which were significantly lower  than the official rate, suggesting overvaluation of the official rate, applied  to all other activities. By 1993, the official rate was 5.7 renminbi per U.S.  dollar and the market rate was 8.7 renminbi per U.S. dollar.
It is the real effective exchange rate that affects Chinese products’ trade  competitiveness. Although the nominal exchange rate of Chinese currency  has remained relatively stable since 1994, the real effective exchange rate  of Chinese currency has shown variations since 1994 (see fig. 9). The  variation is parallel to that of the U.S. dollar because the renminbi has been  pegged to dollar.
Chinese authorities keep controls on foreign exchange earned from  exports and other current account activities through “repatriation and  surrender requirements” on foreign exchange proceeds. Under these  controls, some exporters must sell a significant portion of their previous  year’s foreign exchange earnings to authorized banks at a fixed rate for  China’s currency. China also maintains controls on the use of foreign  currencies related to imports and other outward flows for investment  purposes. For instance, importers must provide proof of import needs and  commercial bills to obtain foreign currencies. Overall, these measures are  less restrictive than those in place in the early 1990s.
In addition to controls related to current account transactions, other  restrictions continue to apply to most capital transactions. For instance,  only certain qualified foreign institutional investors can bring in foreign  capital to invest in the segment of Chinese domestic security markets  denominated in renminbi. Foreign entities can purchase securities  denominated in U.S. dollars more freely. China maintains an “open door”  policy with respect to inbound FDI, but outward investment is limited and  requires government approval. Chinese purchases of capital and money  market instruments abroad are restricted to selected institutions and  enterprises. In 2004, China eased some restrictions on outward capital  flows, including allowing domestic insurance firms to invest a portion of  their portfolios offshore and permitting multinational companies to  transfer foreign exchange among subsidiaries.
section_title: Japan
subsections: section_title: Growth Rate and Trade Balance
paragraphs: Japan suffered from recession and deflation in the years immediately  following the 1997 to 1998 Asian financial crisis (see fig. 10). Its economy  recovered briefly with a 2.8 percent annual growth rate in 2000, declined in  2001, and stagnated in 2002 before picking up again in 2003. Despite  inconsistent growth, Japan has maintained a consistent current account  surplus, which fluctuated between 2.1 percent and 3.6 percent of GDP  during 1998 to 2004 (see fig. 11). Nevertheless, Japan’s trade volume as a  percentage of GDP was 18 percent in 2003 and 20 percent according to  preliminary 2004 data, both of which were less than one-third that of China  for the same years.
Japan’s total foreign exchange reserves increased from $215.5 billion in  1998 to $663.3 billion in 2003 and $833.9 billion in 2004 (see fig. 12). The  rapid increase reflected a reversal of net capital flow direction—from a net  outflow to a net inflow. The rapid accumulation of foreign exchange  reserves in 2003 is attributable to an increase in non-FDI capital inflows.  This increase was due to an equity market rally caused primarily by Japan’s  economic recovery, an increase in the Japanese interest rate in the  summer of 2003, and market anticipation of further yen appreciation. In  contrast to China, Japan has had a steady FDI outflow over time. It ranged  from $23 billion to $32 billion from 2000 to 2003.
The Japanese yen is on an independent float, with the exchange rate  primarily determined by market forces. Japanese authorities have  periodically carried out large interventions in the foreign exchange market  through the sale of yen in exchange for U.S. dollars, resulting in slower yen  appreciation. Japanese authorities intervened frequently in its foreign  exchange markets in 2002, increased the frequency and magnitude of  interventions in 2003, and continued interventions into early 2004 (see fig.  13). U.S. Treasury officials told us they did not think such interventions led  to lasting effects on the yen exchange rate. Since 2003 Treasury has  reported that it actively engages Japanese authorities to urge greater  exchange rate flexibility.
The yen’s real effective exchange rate has fluctuated over the past decade  (see fig. 14). Some market appreciation pressure on the nominal value of  the yen during this period was due to larger capital inflows, particularly a  large inflow from Europe in 1999 and another large inflow in 2003 due to  prospects of higher stock market prices. Strong inflows continued into  early 2004.
section_title: Commonly Used Methods to Determine Equilibrium Exchange Rates
paragraphs: Economists use various methods to analyze whether exchange rates are  misaligned. In general, determining whether a country’s currency is under-  or overvalued involves first determining the country’s equilibrium  exchange rate as a reference or baseline. This is complex because  estimating the equilibrium exchange rate requires information on what  value the exchange rate would attain if it were consistent with a country’s  economic fundamentals at a particular point in time. Different approaches  to estimating equilibrium exchange rates and under- and overvaluation can  yield widely varying results, especially for developing countries, and even  similar approaches can result in different outcomes depending upon which  assumptions and economic judgments are used. Thus, estimates of  undervaluation for China vary substantially—from 0 to 56 percent. This  appendix outlines some of the methodologies commonly used to estimate  the extent of undervaluation of the renminbi.
subsections: section_title: Purchasing Power Parity (PPP) Approach
paragraphs: One methodology commonly used to define equilibrium exchange rates and  determine if a currency is under- or overvalued is the Purchasing Power  Parity (PPP) approach. The PPP approach is rooted in the law of one price,  which states that identical goods in different countries should trade at the  same price. Thus, the equilibrium exchange rate is defined as the exchange  rate at which the general level of prices will be the same in every country  and is calculated as the ratio of the domestic and foreign price levels. The  goods and services analyzed are typically those that make up the GDP of  each country. In some cases, narrower units have formed the basis of PPP  comparisons, such as the “Big Mac” index which is a widely cited shortcut  version that analyzes one standardized good across countries.  Unfortunately, the law of one price has limitations; it does not hold across  nations of sharply differing levels of development and is biased toward  finding undervaluation for low-income countries compared to their higher- income counterparts. Additionally, the approach ignores other important  factors that lead to inequality in prices, such as trade barriers and  nontraded goods. Many experts maintain that PPP measures are more  useful for analyzing cost-of-living differences than inferring the extent of  currency misalignment.
A variation of the absolute PPP approach discussed above is the relative  version of the PPP methodology, which is based on the hypothesis that  changes in the exchange rate are determined by the difference between  inflation rates in the two countries—or, equivalently, the real exchange rate  between two currencies remains constant over time. The technique  involves choosing a point in time that corresponds to equilibrium and then  projecting the new equilibrium rate using the inflation differentials  between countries. This analysis is based on trade-weighted exchange rate  indexes because they are better indicators of overall competitiveness. One  limitation of the approach is that it is very sensitive to the type of price  index used for base calculations (e.g., the consumer price index vs. the  producer price index), and the results depend on the time periods selected  as the base year. The methodology also ignores structural changes in the  economy that might cause the real exchange rate to change over time.
section_title: Fundamental Equilibrium Exchange Rate (FEER) Approach
paragraphs: The FEER approach to assessing currency valuation is based on the  relationship between the current account and capital flows. The FEER is  defined as the exchange rate that will bring the current account balance  (consistent with domestic full employment) into equality with the “normal”  or sustainable capital account balance. Thus, it is the value of the  exchange rate that is consistent with both internal and external economic  equilibrium. The FEER calculation requires macroeconomic or trade  models to obtain the current account position that is consistent with  internal balance, known as the “trend” current account. The second stage  involves determining the real exchange rate changes necessary to ensure  balance between medium-term capital flows and the trend current account.  Within this framework, the equilibrium exchange rate is deemed  “fundamental” in the sense that it is related to the fundamental economic  determinants over the medium term.
Significant limitations of this approach are that it requires extensive  modeling to capture the major trade relationships and economic judgments  that are criticized by some as ad hoc (including a decision about “normal”  or sustainable capital flow levels) and that it relies on estimates of the  sensitivity of demand to prices that are difficult to make. In addition,  changes in the structure of the economy that affect the current account and  the equilibrium exchange rate may introduce further uncertainty in the  estimates. This is important in China’s case because many economic  conditions and institutions are rapidly changing in the move toward a  market-based economy. Also, this approach is difficult to apply to China  because of limitations in the quality of Chinese statistics.
section_title: Macroeconomic Balance Approach
paragraphs: This methodology is based on the premise that there is an appropriate  current account position (external balance) associated with the  equilibrium savings and investment balance within a country (internal  balance). Once the full employment savings-investment position is  established and its associated current account is determined, this approach  uses estimated trade models to determine how much the real exchange rate  would have to change to generate the required external balance.  The  approach is related to the FEER concept because the equilibrium exchange  rate is associated with internal and external economic balances. Similar to  the FEER, this methodology also requires considerable modeling and  economic judgment, and the results are highly sensitive to variations in key  parameters. The IMF notes that in its macroeconomic balance modeling  approach assumptions are used to assess the current account positions and  exchange rates that may not be entirely appropriate for developing  countries. Moreover, the IMF industrial country methodology largely  abstracts from the impact that structural policies and adjustments could  have on the equilibrium savings investment position. Again, this is  important in China’s case because of the many structural adjustments the  country is currently undergoing.
section_title: External Balance Approach
paragraphs: Similar to the FEER and Macroeconomic Balance approaches, this method  is based on the premise that there is an appropriate external account  position. That is, there is a particular level of the current account that  balances the “normal” capital flows so that there is no change in  international reserves. It differs from these two approaches in that it does  not consider internal equilibrium. This approach involves determining the  sustainable external account balance—meaning one appropriate for a  country’s economic situation. Once the relevant external balance is  identified, estimated trade models or rule-of-thumb relationships are used  to determine the exchange rate change needed to generate the target  outcome. This method is highly dependent upon which portion of China’s  external balances is considered. For example, the selection of China’s  current account balance might lead to a finding that the renminbi is not  significantly undervalued, while the broader basic balance might lead to a  finding of substantial undervaluation. The approach also relies on  elasticities that are difficult to estimate or rules of thumb that are not  analytically precise. Moreover, the approach does not include an explicit  consideration of a country’s internal economic equilibrium situation, such  as whether the country is at full employment.
section_title: Behavioral Equilibrium Exchange Rate (BEER) Approach
paragraphs: Under this approach, equilibrium exchange rates are determined through  observing long-run relationships between real exchange rates and the  economic variables that determine them. That is, the BEER approach uses  econometric relationships to model the equilibrium exchange rate, based  on predicted economic relationships derived from an array of relevant  theories. Misalignment of a currency is measured as the difference  between the actual exchange rate and that predicted by the model  variables. However, the determinants of exchange rates and their links to  any underlying notion of economic fundamentals are neither well  understood nor easily predicted. Thus, many complex BEER models do not  predict exchange rates any better than simpler techniques. The BEER  approach also uses a number of simplifying assumptions and precludes the  identification of many other key parameters important to explaining the  economic system. This makes it difficult to judge the plausibility of its  estimates.
Qualitative Approaches Some analysts do not formally define an equilibrium exchange rate, but  look at trends in certain data to determine whether or not a country’s  currency is misaligned. One of the most widely cited trends used to infer  currency misalignment is foreign exchange reserve growth. Some  observers have noted that China has been accumulating reserves at a rapid  pace and conclude that the renminbi must be undervalued. While it is true  that China’s foreign exchange growth has outpaced all other countries,  with the exception of Japan (see fig. 15), using China’s reserve  accumulations as a measure of currency misalignment has limitations. For  example, some analysts have noted that a significant portion of the capital  inflow into China has been short-term speculative money, triggered by  expectations of a renminbi appreciation. Given China’s commitment to a  fixed exchange rate regime, the government must absorb this excess  foreign exchange. Moreover, if China removes restrictions on capital  account transactions, as many have been advocating, some analysts believe  the currency may depreciate due to capital outflow. Thus, while rapid  reserve growth indicates upward pressure on the currency, it does not  necessarily suggest by itself that the current value of the renminbi is lower  than its long-run equilibrium value.
section_title: Factors Influencing the Final Impact of Exchange Rate Changes
paragraphs: An undervalued currency relative to the dollar would tend to make U.S.  exports more expensive and U.S. imports less expensive. However, just  how much cheaper imports would be and the degree of impact on the U.S.  trade deficit, production, and employment would ultimately depend on  complex factors. This appendix discusses some of these important factors.
The impact of China’s currency on the U.S. economy would first depend on  a number of factors that can weaken the exchange rate pass through—that  is, the extent to which a change in the value of China’s currency changes  the price of exports to the United States. These include:  The import content of Chinese exports to the United States. A large  portion of China’s export operations consists of the final assembly of  products using components produced in other countries, especially  Japan, Korea, and Taiwan. Some experts believe that the import content  of Chinese exports to the United States may be 35 to 40 percent of the  total value, and others have estimated as much as 80 percent. An  appreciation of the renminbi could thus have limited impact on the  prices of these exports to the United States because the currency  change would leave the imported portions of the products (as much as  80 percent) unaffected, while a smaller portion (20 percent) would  become more expensive.
The flexibility of the Chinese labor market.  Some researchers believe  that Chinese laborers might willingly take wage cuts to keep their jobs  given the high unemployment rate in the country. Thus, the extent to  which an increase in the value China’s currency increases the price of  exports to the United States would depend on whether a revaluation of  the renminbi leads to lower wages.
The response of foreign-invested enterprises (multinational  companies operating in China). The response of import prices to the  exchange rate would also be smaller if foreign producers absorb the  exchange rate movements in their profit margins to sustain their U.S.  market share. According to Chinese statistics, foreign firms, some of  them U.S.-owned, produced more than 50 percent of all exports in 2002  and accounted for 65 percent of the total increase in Chinese exports  from 1994 to mid-2003.
Once the impact on import prices is determined, the impact on trade flows,  production, and the U.S. economy would still depend on additional factors.
Elasticity of demand. The sensitivity of U.S. demand for Chinese goods  and of China’s demand for U.S. goods to price changes are also  important factors. If U.S. consumers are sensitive to price changes of  Chinese imports (i.e., elasticity of import demand is high), then an  increase in import prices would significantly reduce the demand for  Chinese goods and improve the bilateral trade deficit with China.  Similarly, if the Chinese elasticity of demand for U.S. goods is low, an  appreciation of the renminbi may not result in an increase in the  demand for the cheaper U.S. products.
China’s weight in the U.S.’s overall trade. The trade-weighted dollar is a  measure of the dollar’s value with respect to its major trading partners.  Such indexes are useful for discussion of the relationship between  exchange rates and the aggregate trade balance. According to the  Federal Reserve Board, the renminbi carries a weight of approximately  10 percent in the trade-weighted real effective exchange rate (see fig.  16). Therefore, a 20 percent change in the value of the renminbi means  the Federal Reserves’ trade-weighted dollar would change by roughly 2  percent. Thus, some maintain that a revaluation of the renminbi must be  accompanied by an increase in the value of other currencies to have a  significant impact on the United States’ global trade deficit.
How countries react to China’s exchange rate policies. Some analysts  contend that China’s currency peg to the dollar induces other East Asian  countries to intervene in currency markets to keep their currencies  weak against the dollar so that they can remain competitive with China,  thus magnifying the impact of China’s currency on the United States.  Moreover, they conclude that a revaluation by China would encourage  other countries to follow. As a result, there could be a large enough  change in the trade-weighted dollar to impact the United States’ global  trade deficit.
Labor-intensive tasks once performed in other countries are now  being performed in China. As figure 17 shows, while the portion of the  U.S. merchandise trade deficit accounted for by Japan and the rest of  East Asia has fallen since 1999, China’s share has risen. This reflects the  fact that exports from Japan and other East Asian countries to the  United States are now increasingly finished and exported from China.  For example, from 2000 to 2002, U.S. imports from China increased by  $25.2 billion, while imports from Japan fell $24.5 billion. The extent to  which Chinese exports to the United States are substituting for exports  that would otherwise have entered the United States from alternative  low-cost countries makes the impact on the U.S. economy difficult to  quantify.
The role of cheap labor.  Many believe that China competes primarily in  terms of low labor costs. There are also a number of other countries  whose manufacturing wages are only a fraction of those in the United  States (see fig. 18). As a result, some believe a renminbi appreciation  would not induce increased output in American factories. Instead, U.S.  imports from other low-wage foreign suppliers would increase. If this is  true, the bilateral trade deficit with China would decrease, but the trade  deficits with other low-wage countries would increase, leaving the  overall trade deficit unchanged (or slightly worse due to more expensive  imports).
Degree of competition. The effects of the exchange rate are stronger  when countries compete in similar markets. Some researchers maintain  that the overlap between the production of China and the United States  is small; that is, relatively few imports from China compete with  domestic production in the United States. Others believe that the market  competition is high enough that Chinese imports have displaced U.S.  workers.
Lastly, potential income effects on China and economic interdependence  between major trading partners are relevant to exchange rate impacts. For  example, some experts have concluded that an appreciation of the  renminbi would reduce employment, income, and growth in China, thereby  affecting Chinese demand for U.S. exports. Similar forces must be  considered for the United States, although it is unclear whether they would  be significant given the distinct effects on the various sectors of the  economy. Some believe that an appreciation of the renminbi (especially if  accompanied by the elimination of capital restrictions) would lead to  economic and financial instability in China and jeopardize other Asian  countries that rely in part on exports to China to sustain their economies.  Such instability in East Asia, if it were to occur, would likely have negative  repercussions on the U.S. and global economies.
section_title: Net Foreign Purchases of U.S. Securities
paragraphs: China has in recent years purchased substantial amounts of U.S. securities,  mostly agency bonds and U.S. Treasury securities (see table 5). However,  China’s net purchases are not as large as those of the United Kingdom and  Japan. Like other foreign central banks, China’s central bank has chosen to  purchase large quantities of U.S. Treasury securities with renminbi in part  because it can buy and sell them quickly with minimal market impact.  According to monthly data compiled by the Treasury International Capital  System, China’s investment in U.S securities climbed sharply during the  2000 to 2003 period, but was lower in 2004. This appendix presents detailed  tables on foreign transactions in U.S. securities. While these transactions  data are useful for showing China’s relative size in overall securities  purchases, they have certain reliability limitations which are noted in the  table and are further discussed in appendix 1.
section_title: Comments from the Department of the Treasury
section_title: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts
section_title: Acknowledgments
paragraphs: In addition to the persons named above, Lawrance Evans, Jr., Jane-yu Li,  Jamie McDonald, Donald Morrison, and Richard Seldin made major  contributions to this report.