A test of relationship between real exchange rate and foreign trade balance under the Marshall-Lerner Condition: Based on China-USA trade

One of the reasons for the economic tensions between China and the US today is the foreign trade imbalance between the two countries. Those who argue that this imbalance stemmed from the manipulation of the exchange rate reveals that the Chinese Yuan is trying to keep the exchange rate low. In this study, the effects of the exchange rate on foreign trade were investigated and it was decided that the Yuan exchange rate is not the factor that disrupts the trade balance between China and USA. Since a new foreign exchange reform took place in China in July 2005, the data used in this study consisted of quarterly data covering Q3 - 2018: Q2 periods. The study included the foreign trade balance as an independent variable, the dependent variables were the real exchange rate, and the industrial production indices representing the price level of China and the USA. The bounds test based on ARDL model was applied by taking into account the different order stability of the variables. As a result of the study, the bounds test was valid at 5% significance level and long term relationship was found between the variables. However, the real exchange rate coefficient representing the Marshall-Lerner condition was statistically insignificant. Thus, the Marshall-Lerner condition was invalid for the People's Republic of China, and the exchange rate in China proved to be not a factor affecting the foreign trade balance between the two countries.