From 1994 until July 21, 2005, China maintained a policy of pegging its currency to the U.S. dollar at an exchange rate of roughly 8.28 yuan to the dollar. The Chinese central bank maintained this peg by buying (or selling) as many dollar-denominated assets in exchange for newly printed yuan as needed to eliminate excess demand (supply) for the yuan. As a result, the exchange rate between the yuan and the dollar basically stayed the same, despite changing economic factors which could have otherwise caused the yuan to either appreciate or depreciate relative to the dollar. Under a floating exchange rate system, the relative demand for the two countries' goods and assets would determine the exchange rate of the yuan to the dollar. Many economists contend that for the first several years of the peg, the fixed value was likely close to the market value. But in the last few years of the peg, economic conditions changed such that the yuan would likely have appreciated if it had been floating. The Chinese government modified its currency policy on July 21, 2005. It announced that the yuan's exchange rate would become "adjustable, based on market supply and demand with reference to exchange rate movements of currencies in a basket," (it was later announced that the composition of the basket includes the dollar, the yen, the euro, and a few other currencies), and that the exchange rate of the U.S. dollar against the yuan would be immediately adjusted from 8.28 to 8.11, an appreciation of about 2.1%. Unlike a true floating exchange rate, the yuan would (according to the Chinese government) be allowed to fluctuate by 0.3% (later increased to 0.5%) on a daily basis against the basket, it remained not fully convertible in international markets, and China continued tight restrictions and controls over capital transactions. The current situation might be best described as a "managed float"—market forces are determining the general direction of the yuan's movement, but the government is retarding its rate of appreciation through market intervention. Since July 2005, China has allowed the yuan to appreciate steadily, but slowly. It has continued to accumulate foreign reserves at a rapid pace, which suggests that if the yuan were allowed to freely float, it would appreciate more rapidly. China's foreign exchange reserves grew from $403 billion at the end of 2003 to $1.7 trillion at the end of March 2008, and China's large trade surplus totaled $262 billion in 2007. Since the 2005 reforms, there has been a significant shift in the economic environment in China and the United States. The yuan has risen 16% against the dollar—far more than the Japanese yen during the same period, for example. The overall value of the dollar has fallen significantly, to the point where some economists and policymakers fear that a further fall could be destabilizing to the U.S. economy. (By definition, any rise in the yuan is equivalent to a fall in the dollar.) Partly as a result of the falling dollar, total U.S. exports are the fastest growing sector of the economy, and the growth rate of imports from China appears to have slowed recently. Nevertheless, the increase in the value of the yuan to date has done little to ease concerns raised in the United States. But China, with concerns about its own economy, has been reluctant to make significant changes to their currency. This paper reviews the various economic issues raised by China's present currency policy. Major topics surveyed include The economic concerns raised by the United States over China's currency policy and China's concerns over changing that policy. How China's fixed exchange rate regime works and the various economic studies that have attempted to determine China's real, or market, exchange rate. Trends and factors in the U.S.-China trade imbalance. (What is causing it? Is China's currency policy to blame?) Economic consequences of China's currency policy for both China and the United States. China's massive accumulation of foreign exchange reserves and purchases of U.S. federal debt instruments. Policy options on how the United States might induce China to reform its present currency policy, including current legislation introduced in Congress. Many U.S. policymakers, business people, and labor representatives have charged that China's currency is significantly undervalued vis-à-vis the U.S. dollar by as much as 40%, making Chinese exports to the United States cheaper, and U.S. exports to China more expensive, than they would be if exchange rates were determined by market forces. They further argue that the undervalued currency has contributed to the burgeoning U.S. trade deficit with China, which has risen from $30 billion in 1994 to $256 billion in 2007, and has hurt U.S. production and employment in several U.S. manufacturing sectors (such as textiles and apparel and furniture) that are forced to compete domestically and internationally against "artificially" low-cost goods from China. Furthermore, many analysts contend that China's currency policy induces other East Asian countries to intervene in currency markets in order to keep their currencies weak against the dollar to remain competitive with Chinese goods. Several groups are pressing the Bush Administration to pressure China either to revalue its currency or to allow it to float freely in international markets. These issues are addressed in more detail later in the report. President Bush and Administration officials have criticized China's currency policy on a number of occasions, stating that exchange rates should be determined by market forces. Initially, the Bush Administration rejected calls from several Members of Congress to apply direct pressure on China to force it to abandon its currency peg. Instead, the Administration sought to encourage China to reform its financial system—under the auspices of a joint technical cooperation program agreed to on October 14, 2003, for example—and take other measures that would pave the way toward adopting a more flexible currency policy. The Administration's position on China's currency peg appears to have toughened beginning around April 2005 when then-U.S. Treasury Secretary John Snow asserted at a G-7 meeting (on April 16, 2005) that "China is ready now to adopt a more flexible exchange rate." This was likely driven in part by growing complaints from Members over China's currency policy and the introduction of numerous currency bills. For example, during the 109 th congressional session, the Senate on April 6, 2005, failed (by a vote of 33 to 67) to reject an amendment ( S.Amdt. 309 ) attached by Senator Schumer to S. 600 (a foreign relations authorization bill), which would have imposed a 27.5% tariff on Chinese goods if China failed to substantially appreciate its currency to market levels. In response to the outcome of the vote, the Senate Republican leadership negotiated an agreement with the supporters of the bill to allow a vote on S. 295 (which was sponsored by Senator Schumer and which has same language as S.Amdt. 309 ) at a later date as long as the sponsors of the amendment agreed not to offer similar amendments to other bills for the duration of the 109 th Congress. Supporters of S. 295 threatened to bring the bill up a vote on the bill on two separate occasions in 2006, but were convinced not to by Administration and Chinese officials. Numerous other currency bills were introduced as well. Over the past year, some of the most significant events concerning China's currency policy have included the following: On May 13, 2008, the U.S. Bureau of Labor Statistics reported that, from April 2007 to April 2008, import prices from China increased 4.1%—the largest 12-month increase recorded since the index was first published in December 2003. On May 9, 2008, the U.S. Census Bureau reported that U.S. imports from China over the first three months of 2008 had risen by only 1.8% over the same period in 2007. On May 8, 2008, the Bank of China reported that the exchange rate with the dollar was 7.00 yuan, an appreciation of 15.9% since the July 2005 were introduced. On April 14, 2008, the Bank of China reported that China's foreign exchange reserves reached $1.68 trillion at the end of March 2008. On September 29, 2007, the Chinese government officially launched the China Investment Corporation (CIC), stating that the new entity was created to better manage its foreign exchange reserves. With an initial capitalization of $200 billion, CIC is one of the world's largest state-owned funds. On December 15, 2007, the CIC announced it would invest $5 billion in Morgan Stanley. On August 13, 2007, China's Xinhua News Agency reported that China had no plans to sell off its dollar assets. The statement appeared to be in response to an article that appeared in the Daily Telegraph (August 10, 2007) in which high level Chinese government officials reportedly claimed that China would sell off its dollar assets if the United States imposed sanctions against China over its currency policy. In addition, the government announced the elimination of regulations requiring domestic firms to convert part of their current-account foreign exchange holdings into yuan. In June 2007, the International Monetary Fund clarified its definition of currency manipulation as "engaging in policies that are targeted at—and actually affect—the level of the exchange rate...in order to increase net exports." To discourage currency manipulation, the IMF announced it "must be prepared to deliver clear and sometimes difficult policy messages to members...." On May 17, 2007, 42 House Members filed a Section 301 petition with the U.S. Trade Representative's office over China's currency practices and requested that a trade dispute case be brought to the World Trade Organization (WTO). On June 13, 2007, the USTR's office announced that it had declined the petition.