A ‘Murderous' Route


Written by Mohiuddin Aazim • Special Features • April 2010

China's economy is overheating. Its policymakers must focus on sustaining economic growth rather than trying to accelerate it.Some may like to call it China's murderous exchange rate policy. But that is a bit of an exaggeration. The way China is managing its exchange rates, it is overly cautious which carries the risk of slowing the pace of global economic revival. Fast-paced economic growth in China over the last three decades has made it the second largest economy of the world. More importantly, it has also emerged as the world's top exporting country.

Keeping export growth at a rate that may help China retain its number one position in global export business requires a couple of things. And disallowing a rapid readjustment in the exchange rate is one of them.
China continues to shun mounting U.S. demands for a stronger Yuan, saying that its trade surplus is not because of any undue advantage of its exchange rate and vowing to keep the currency stable to shore up exports.

Beijing and Washington appear to be locked in a dialogue of the deaf in the run-up to a U.S. Treasury Department report due on April 15 that will determine whether China is manipulating its exchange rate for trade advantage.

Chinese Commerce Ministry spokesman Yao Jian has rejected the argument that China's hefty trade surplus with the United States was due to the Yuan, also called the renminbi, which some U.S. economists judge to be 25 percent undervalued. "The trade surplus is not caused by the renminbi exchange rate. The trade surplus is an outcome and phenomenon of globalization. It will exist for a time," he said.

Yao was speaking a day after 130 U.S. lawmakers demanded that President Barack Obama get tough with China over its currency practices, which they say undercuts the competitiveness of U.S. manufacturers. "The impact of China's currency manipulation on the U.S. economy cannot be overstated. Maintaining its currency at a devalued exchange rate provides a subsidy to Chinese companies and unfairly disadvantages foreign competitors," the legislators said in a letter. If the Treasury does rule that China is manipulating its exchange rate, the U.S. government would be required in principle to start "expedited negotiations" on the issue.
Yao asked rhetorically whether China, which has a trade deficit with Japan, South Korea and some developing countries, should copy the United States and pass a law to deal with those countries. "So we hope that in surmounting the crisis and reviving its economy, the United States should be a promoter of free trade, not an obstacle to it," he said.

The United States' annual trade gap with China fell to $226.8 billion in 2009, down from a record $268.0 billion in 2008. But with the Obama administration keen to lift exports and employment, the deficit remains a point of friction between the two powers, which have also recently been at odds over human rights, Tibet and U.S. arms sales to Taiwan. China has kept the Yuan pegged at around 6.83 per dollar since July 2008 to help its exporters.
If it revalues its currency on the U.S. demand, the Chinese exporters would lose edge over their competitors and thus the rate of overall export growth of China would decline. This would facilitate America to accelerate its own exports. If Yuan is revalued realistically American imports from China would also decline and thus help in reducing rising U.S. trade deficit with Beijing.

Countries of the European Union as well as Japan and the UK are pursuing China to adopt a realistic exchange rate policy for similar reasons. All of them need to accelerate their export growth to recover from the ill effects of the Great Recession of 2007-09. And that is not possible if the Chinese exporters continue to enjoy the benefits of an undervalued Yuan for long.

The international community's concern about Beijing's exchange rate policy has grown after the Great Recession of 2007-09. But the Americans had long been insisting on China to revalue its exchange rates. It was during the second term of President George Bush that America started building pressure on China to give up its protective exchange rate policy. The Obama administration continues to intensify this pressure. The Great Recession has provided the Americans more reasons to urge China to open up its exchange rates regime-a demand well supported well by the IMF and the World Bank. But Mr. Obama is more tactful in its economic diplomacy with China than Mr. Bush for the obvious reason that China has now become a top trade partner of the U.S.A. Besides, Americans have strategic interest in South Asia that cannot be served well if it pursues a policy of confrontation with Beijing.

Whereas Chinese are not willing to set a deadline for removing the Yuan-dollar peg, the world in general and America in particular is interested in knowing when exactly that would happen.
From Chinese perspective only a gradual and well-calculated liberalization of exchange rate regime is advisable. Chinese Commerce Minister Mr. Chen Deming said, in a March 8 interview with Reuters in Beijing that halting the Yuan's appreciation since mid-2008 was part of a set of pro-growth policies to prop up the economy during the global credit crunch. After allowing some revaluation in mid-2008 China has effectively re-pegged its exchange rate at around 6.83 Yuan per U.S. dollar to help its exporters take over the world export market. That made some sense till 2009 as Chinese exports growth and the resultant miraculous growth in the Chinese economy accelerated the pace of global recovery from Great Recession.

But as the world has moved out of the Great Recession in 2010 Beijing is now under intense pressure to remove the peg. "The movement and degree of stability in the Yuan in times of crisis ought to be different from when there is no crisis," remarked Mr. Deming indicating that Beijing might eventually liberalize its exchange rate regime. But he asserted that the direction of Yuan reform would be gradual and controlled.

Protectionists in China argue that a rather conservative Chinese financial regulatory framework had kept its financial system unhurt in the wake of the American financial crisis of 2007 that finally led to the Great Recession. They further argue that a gradual and controlled Yuan reform would not only protect China against the risks of a double-dip recession but would also be helpful in maintaining economic stability in the region.

But as President Obama puts it China has become a potentially overheating economy. In other words Chinese policymakers must now focus on sustaining economic growth rather than trying to accelerate it further.

Apart from the American-Chinese clash of perspectives over the need and the timing of the desired Yuan reforms a more important question is whether the Chinese ‘reluctance' to revalue the Yuan is impeding the rebalancing of the global economy?

Well, the answer is YES. Or perhaps NO! It depends on what envisions the rebalancing of the global economy. If the global economy is to be rebalanced to leave little room for the repeat of the financial crises seen in 2007 and earlier in the mid 90s-and if the rebalancing is aimed at better distribution of global resources then countries like China need to get rid of protectionist policies. But if the rebalancing is aimed at protecting the present financial and economic structure of the world after some cosmetic surgeries then it makes little difference whether or not China bows to the world pressure of opening up its exchange rates regime.
Fortunately, a vast majority of policymakers around the world are looking for the rebalancing of the first kind. That being the case further delays in the Yuan reforms would likely impede the rebalancing of the global economy.