A US-China Solution to Climate Change & the Trade Deficit

I. Introduction

After reading a recent news article about President Obama meeting with the president of the People’s Republic of China, I was not surprised to discover that, although somewhat amiable, the two presidents and the two countries were still at an impasse regarding both climate change and economic issues. From my understanding, neither country is willing to fully pursue an appropriate climate change policy that may cede any economic ground to the other country. Furthermore, as China looks to quickly modernize or develop its economy, it is in perhaps a weaker position to address climate change than the US. Conversely, as the US is currently in debt to China on the order of approximately $800 billion and has simultaneously been running a trade deficit with China that has grown on average by 17% per year for the past decade[1], it is in a somewhat weaker position to make economic demands. Seeing these two disparities, I questioned whether the two issues could be combined in order to solve both issues while allowing both countries and the world to benefit.

II. Exchange Rate

The key to a solution lies in China’s current policy that fixes exchange rate between the Chinese Yuan (CNY) and the US Dollar (USD), which currently stands at approximately 6.83 CNY to 1 USD. By holding the CNY at this ratio, China is able to make its goods cheaper on international markets and make imports more expensive. This financial tactic is often cited as one of the factors exacerbating the US-China trade deficit.

III. The Proposal

Similar to the dual problem being addressed, my proposal contains two primary components. The first is for China to agree to incrementally lower the value of its currency over the next decade. The second is that in exchange the US agrees to take on some China’s responsibility to address climate change. Specifically, my proposal is that over the next decade the US will agree to offer domestic renewable energy subsidies equivalent to value that it saves on the trade deficit due to the adjusted rate of exchange. This strategy could allow the US to annually offset (or prevent) a significant amount (approximately 1.8x1010 MT between 2010 and 2039) of greenhouse gas emissions compared to the current, combined annual emissions of the US and China.[2]

IV. Rate Adjustment

Just as the USD-CNY exchange rate is the key to the solution, the adjustment rate of the exchange rate is the key to determining the viability and impact of the program. While a variety of models are possible, I have chosen a relatively simple model to calculate my results. The model I am proposing calls for China to decrease the exchange rate by a certain percentage each year over the coming decade. Doing so would result in an exchange rate at the beginning of 2020 that is in the range of 6.18:1 to 4.09:1 (CNY:USD) for adjustment rates of 1% to 5% annually.

V. Potential Costs to China

Without question, this program would cost China money. Table 1 shows the cumulative value of costs (based solely on US-China trade deficit figures) to China over the course of the program (from the beginning of 2010 to the end of 2019) in billions of 2010USD at different adjustment rates (rows) and discount rates (columns). While the costs listed in Table 1 only reflect the loss in value from US-Chinese trade, China would also incur additional costs in trade with other countries for which I have not yet accounted. However, assuming that this is seen by the international community as the cost of China continuing to grow its economy in the face of the looming climate change impacts, the costs may be justifiable.


Just how much China would be willing to pay may be a matter of negotiation. As such, this program should merely be one of many tools used to solve the issues put forward in the introduction section rather than an all-inclusive set of actions. Further, the scale of these values should be put into perspective. For example, the 2008 annual US-China trade deficit was $268 billion (not discounted) or in other words 16% of the most costly scenario in Table 1 or 250% of the cheapest scenario in Table 1. Another point of reference is that the US’s debt to China as of September 2009 was about $800 billion (not discounted). With these points of reference in mind, all of the potential costs seem fairly reasonable if not negligible.

VI. Hurdles for the US

In order for this program to be as successful as possible, the US must be willing to use truly renewable energies with the highest possible MWh/$ ratio with the greatest potential to rapidly scale-up over the coming decade. As such, my primary suggestion is to fully invest in large-scale (2 MW or greater) wind turbines, which to my knowledge offer the greatest MWh/$ ratio currently available (approximately $1.6 million per MW of installed capacity) for low-GHG emission energy sources.[3] In this scenario, I suspect that the biggest hurdles to overcome would be NIMBYism (Not-In-My-Backyard objections) and ensuring that the utility grid infrastructure can support the variable energy generation provided by wind turbines.

VII. Assumptions

In order to perform calculations, I was forced to make several assumptions and estimations. In this section I will explain many of these assumptions and estimations and justify my reasoning for each of them.

1. Trade Deficit Growth

The first assumption was that although the US-China trade deficit varies greatly from year to year, it has tended to increase by an average of 17% per year over the past decade. Therefore, I assumed that over the next decade it is likely to do the same. Of course, due to the semi-chaotic variability of international markets, this may not be a safe assumption, so I also looked at some practical limitations to this assumption.

Firstly, if the trade deficit grows more rapidly than 17%, then the result will be that more savings will be realized by the US due to a reduction in the exchange rate. Therefore, although economic relations between the US and China may be further strained compared to current conditions, the greenhouse gas emissions program would receive greater funding. As such, so long as the rate of growth does not surpass some critical value that causes the US economy to disintegrate, from an overall benefits perspective this seems to be a neutral outcome. Furthermore, considering the fact that the disparity between the USD and the CNY will be shifting in favor of the US, it seems more likely that the trade-deficit growth will slow rather than accelerate. However, so long as the growth does not slow by more than 13% per year (at which point the US-China trade deficit will be essentially non-existent by 2020), which seems rather unlikely, the program will still be viable. In fact, even if the average trade-deficit growth decreases by 6% annually (meaning that the trade deficit will peak during 2011 and start decreasing during 2012), the benefits of the program are still substantial.

2. Discount Rate

Another matter that needs to be considered in the case of a long-term venture such as this is the discount rate. With no discount rate applied, the program is extremely viable for all proposed adjustment rates. For any of the proposed adjustment rates, a discount rate of up to 2.75% allows for emissions reductions that are about half of those for a 0% discount rate, and a discount rate of up to 5.5% yields emissions reductions that are about one quarter of those for a 0% discount rate.

3. Technology Rate

Due to the nature of renewable energy research and deployment, it is also important to anticipate a decrease in the cost of renewable energies due to advances in technology, which for simplicity’s sake I have termed the technology rate. While the viability of the program would only be increased by a positive technology rate (causing decreasing costs over time) and is therefore not a concern, estimating a reasonable technology rate allows for a more accurate estimate of the total impact of the program and the degree to which the effects of discounting can be offset. I have assumed a technology rate of 3.5%.[4]

One caveat to the technology rate assumption is that an effectively negative technology rate could be experienced if supply could not be scaled up to meet the newly created demand for renewable energies in a timely fashion. However, I believe that an essentially reliable source of funding and demand over the next decade will merely persuade more suppliers to appear and for current suppliers to invest more heavily in scaling up and improving technology to remain competitive. Therefore, if anything, I suspect that this technology rate may be too low.

4. Wind Turbine Limitations

In the particular case of wind turbine deployment, the capacity factor is crucial in determining the amount of energy produced (and the emissions prevented). For all cases I have assumed a capacity factor of 25%, which means that on average each turbine will be producing 25% of its name plate capacity. In other words for each MW of installed generation capacity, 0.25 MWh will be produced each hour on average. Obviously higher capacity factors will yield greater reductions in emissions just as lower capacity factors will yield lesser reductions in emissions. However, predicting such figures exactly is not practical. Therefore, I have chosen to use a reasonable (although arguably low) capacity factor.[5] In addition to capacity factor, the operating lifetime of installed wind turbines will also be a factor in determining the total electricity generated as a result of this program. To be conservative, I have assumed that each wind turbine will have to be decommissioned twenty years after its installation.

VIII. Results

Based on the assumptions stated in the previous section, I calculated a variety of potential outcomes. Figures 1-5 below depict some of the trends in values that can be expected for different currency adjustment rates and a discount rate of 2.75%.

Figure 1 shows the potential wind capacity that could be installed each year during the program. Note that the last year in Figure 1 is 2019 since this would be the last year that China would be obliged to adjust its exchange rate and that the US would be obliged to continue funding the subsidy. While Figure 2 shows the cumulative capacity that would be available as a result of the program. Given the assumption that I have made about wind turbine lifetimes, the direct impact of the program would not exceed the end of 2039.


Figures 3 and 4 show annual electricity generation and annual avoided greenhouse gas emissions respectively. Note that the trends depicted are identical in shape, because I calculated the avoided greenhouse gas emission by simply multiplying the electricity generation by a factor of approximately 0.609 eCO2 per MWh.[6] The generation and avoided emission do not start until 2011, because presumably the turbines would still be under construction during 2010 and not producing substantial amounts of energy. There is also a decline in the trends after 2031 as the first set of turbines are decommissioned. Although, in reality some turbines may fail prior to this date and others may still be useful well past the predicted lifetime, which would mean that the trends would start to decrease sooner but trail off much more slowly. Admittedly, the values in Figure 4 do not take into account for greenhouse gas emissions associated with production and installation of the turbines. However, in reality this impact would only impact the years in which installations occur (2010-2019), and I suspect it would be relatively negligible if it were amortized over the lifetime of the turbines. Furthermore, any emissions associated with maintenance would likely pale in comparison to the emissions associated maintaining and providing fuel for most other generation types.


Figure 5 shows the value (in millions of 2010USD) of annual energy production. This estimate uses an average US electricity rate of 9.5¢/kWh. Unfortunately, I do not know how to predict with any amount of certainty how much this rate will fluctuate over the course of the lifetime of this program. Therefore, I have simply left it constant. These values also do not account for secondary values that may be associated with installation such as Renewable Energy Credits. The trend shown in Figure 5 depicts an increase in value during the installation period (2010-2019), followed by a slight decrease as energy generation remains constant (2020-2031) and the effects of the discount rate dominate, and ends in a sharp decrease after 2031 as the effects of the discount rate combine with the loss of generation capacity as turbines are decommissioned.



IX. Conclusions

If this program is successfully implemented, wind energy could annually generate an amount of electricity equivalent to 4.8% to 36% of the total amount of electricity generated in the US during 2008[7] for the decade of the 2020s. Furthermore, if the renewable energy subsidies required a 2:1 or 3:1 match on the part of investors, the impact of this program could be double or triple the values that I have calculated. Concurrently, the disparity between value of the US Dollar and Chinese Yuan could be lessened, and the “you first” climate change deadlock between the US and China could be resolved. During negotiations, this solution could be taken a few steps further if (1) China agrees to peak its greenhouse gas emissions during the 2020s and (2) the US agrees to start actively reducing its debt to China during the 2020s.

Finally, while this entire proposal may seem like wishful thinking to some, I feel that its scope is realistic and achievable even if the timeline might need to be adjusted one or two years into the future. However, I recognize that for this program to be successfully implemented, it will take a great deal of action in a lot of areas where rhetoric may be a more common response to problems. Therefore, I remain hopeful but unoptimistic.