March 30, 2010
The US Treasury is expected to issue its semi-annual report on 15 April. Will it declare China a “currency manipulator”? This would be “for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade.” This could lead to the imposition of countervailing duties on Chinese imports.
The possibility of the Treasury decision was low under President George W Bush but much more likely under President Obama. The Democrats are by nature less free traders than the Republicans. The current Congress and the trade unions – staunch Obama supporters – have been applying political pressure in favour of the decision. They see the value of the currency directly linked to the trade deficit and the loss of jobs.
Congressional critics and others argue that this currency manipulation is a major contributor to global trade imbalances. Nobel Prize-winning economist Paul Krugman said that global economic growth would be about 1.5% higher if China stopped restraining the value of its currency and running trade surpluses. Not all economists agree that the revaluation of the yuan would substantially spur global economic growth.
The yuan was tied to the dollar for decades, but the link was broken in 2005 and allowed to rise by about 20% through late 2008. Beijing then re-imposed the link after the currency crisis occurred.
Beijing argues that the causes of global economic imbalances are manifold and complex, and the responsibility of addressing such imbalances should not be put on China’s foreign trade alone. It contends that the basic stability of the RMB exchange rate during the international financial crisis contributed significantly to world economic recovery.
It is questionable whether the value of the yuan seriously contributes to the trade deficit and the loss of jobs. The deficit is with Asia, rather than China alone. If Chinese goods become less competitive, they will be replaced by imports from Vietnam, Cambodia, Philipines etc. Jobs will not return to the US because domestic production remains uncompetitive.
Beijing cites the decline of China’s total trade volume in 2009 of 13.9%. Exports to China by 37 countries apparently show that nearly half of these countries increased their exports to China. The US exported 17% less to the rest of the world in 2009, but the fall in exports to China was only 0.22%.
Beijing therefore argues that the appreciation of a country’s currency has only limited impact on trade imbalance. While China has a trade surplus with some developed countries, it has deficits with some developing countries, including Japan and South Korea. Trade surpluses and deficits result from globalization and not exchange rates.
In the 1980s, says Beijing, the US threw the Japanese economy into recession by insisting on the continuous appreciation of the Japanese yen, which. However, the US trade balance did not improve.
The RMB appreciation against the dollar was 21% between 2005 and 2008, but China’s external trade surplus increased. In 2009, China’s trade surplus fell by 34.2%, although RMB exchange rate relatively unchanged. The surplus has fallen a further 50.2% in the first two months of this year. This shows that the exchange rate is not the major factor affecting a country’s trade balance.
China also maintains that, as an important export market for the US and Europe as well as its neighbouring countries, it plays a constructive role in promoting global economic recovery
Beijing’s current attitude is revealed by Premier Wen Jiabao’s statement at his press conference on 13 March that, “First of all, I don’t think the renminbi is undervalued.” He rejected foreign pressure over its exchange rate controls and said that the Chinese currency will be kept “basically stable.”
Krugman advocates the US taking a tough line with China. “Without a credible threat, we’re not going to get anywhere,” he said. “The chance that we would trigger a trade war is very small and it’s hard to see any alternative.” “We should not be afraid of what the Chinese might do if we pressure them to stop this currency manipulation,” Krugman said.
What will happen is essentially political, although it would have serious economic effects. Despite the Treasury decision, the US is not bound to impose duties. Any action would presumably be challenged by China in the WTO. Another possibility is that there would be Chinese retaliation, and this is likely to escalate into a trade war, despite Krugman’s sanguinity. This trade war could well spread to Europe. China would seriously suffer from a trade war, as would Europe and the US.
The most satisfactory solution would be a negotiated agreement, but Beijing may dig its toes in and refuse to change its currency policy under foreign pressure. Wen Jiabao promised the reform of currency controls but gave no indication as to when that might happen. ”We will continue to reform the renminbi exchange rate regime and will keep the renminbi basically stable at an appropriate and balanced level,” Wen said.
The likelihood of a Treasury decision increases as the number of bilateral spats increase: Iranian sanctions, intellectual property, tyres, steel pipes, Google, cyberspace attacks…
The ‘megaphone diplomacy’ is worrying, with both sides painting themselves into corners. Wen Jiabao ill-advisedly insisted that the RMB was not undervalued. This view was unnecessarily expressed and makes it more difficult for Beijing, were it in its interests to compromise. The issue is not whether the currency is undervalued but whether it has the results alleged.
China will only change its policy if it believes this to be in its interests and is not seen to be bowing to foreign pressure.Author : Stanley Crossick