For eight years, the Bush administration avoided labeling China as a currency manipulator, but now President Barack Obama’s Democratic administration is coming under pressure from its own Congressional caucus to call out the PRC by name.
In recent weeks, Obama has twice raised the issue in public, in his first State of the Union address and in a meeting with Democratic Senators, after which the Chinese Foreign Ministry spokesman declared harshly that the country would resist any foreign pressures to alter its monetary policy.
The U.S. has been urging China to allow the yuan to revalue, enhancing Chinese consumers’ buying power and theoretically reducing pressure on American manufacturers. Revaluation would likely accelerate the growth of U.S. exports to China, which the Wall Street Journal reports grew at an unprecedented rate of 65 percent year-on-year in January.
Following past precedent, it seems increasingly likely that China will permit a small but significant one-time appreciation of the yuan, probably 3 to 5 percent. The increase will possibly be followed by an announcement that the yuan will be tied to a new, unspecified basket of currencies that allows very gradual revaluation.
Beijing is torn between a larger one-off increase, or a gradual increase, fearing the latter would invite hot money back into China precisely when the government is trying to head off inflation.
On the fact of the yuan’s undervaluation, there is relatively little dispute, though views vary as to how much. The Peterson Institute of International Economics reported last year that China’s currency is about 25 percent undervalued against the U.S. dollar. China, in fact, allowed the yuan to float upward from 2005 to 2007, during which time it appreciated about 18 percent.
Then the global financial crisis took a huge toll on Chinese exports, causing Beijing to suspend the gradual revaluation of the yuan. At first, this was seen as somewhat stabilizing. The dollar and yuan moved in lock step, increasing in value relative to other currencies and averting a race — particularly among Asian trading partners — to devalue in hopes of protecting exporters and saving jobs.
In time, however, the phenomenon reversed, as emerging markets recovered and investors withdrew from the safety of the dollar markets. Now the yuan is quite weak against the euro and trade tensions are building rapidly with the EU, while China continues using its weakened currency to stem job losses.
The practical consequences of calling out China by name are untested. Presumably, Congress would press the office of the U.S. Trade Representative to bring a case against China in the World Trade Organization’s dispute mechanism. Since such a case is without precedent, most knowledgeable observers believe it would fail to result in sanctions against Beijing.
Alternatively, Congress could justify new legislation on the basis of seeking remedy from China’s unfair trading advantage. Senators Chuck Schumer and Lindsey Graham have proposed similar legislation to impose tariffs on Chinese exports, but ironically, they would probably give China justification to pursue and win a case for countervailing action against the U.S. in the WTO.
As authorities in Beijing recognize, China faces increasing trade tensions in its principal export markets at just the moment when those markets cannot grow as fast as they had been. This returns PRC policymakers to their core dilemma of how to promote domestic consumption and sustain a high level of economic growth as reliance on exports falls.
Within China, officials argue that raising the value of the yuan will kill jobs when China needs them most, promoting social instability, Chinese leaders’ greatest fear. They also argue China should use this moment to grab market share.
On the other side are macroeconomic managers who know that export markets will not grow and may even shrink, largely due to reduced U.S. consumption. They are struggling to promote even more domestic consumption, which Xinhua said constituted 4.4 percent of last year’s 11.7 percent GDP growth — the highest in seven years.
So far, Beijing appears unprepared to address its central problem: excessive investment fed by under-priced capital. As my Carnegie colleague Michael Pettis demonstrates, corporate and personal savings are not well-rewarded in China, and their capital is re-lent to fund capacity building and speculation.
From initial indications, China looks likely to take several measures that will be minimum necessary treatments rather than cures for the issues it faces. Earlier this month, for example, the government authorized wage increases in several locations, possibly in anticipation of a broader policy to allow increased salaries.
Higher wages would address both the need for stronger domestic consumption in the face of weakening exports and incipient inflation, as the government withdraws its stimulus measures, without immediately raising the price of Chinese exports. From the U.S., Japanese and European points of view, the move would not be as effective at promoting imports as allowing the yuan to appreciate.
And there have been hints ever since the November Economic Central Work Conference that China intends to begin a very gradual revaluation of the yuan. Beijing insists that it is addressing this problem in its own interest.
If China continues along this path, it will reduce pressure on the Obama administration to find it “guilty” in advance of the April 15 deadline for the U.S. Treasury to report global currency manipulation to Congress. This would help dodge one of the bullets of the current season in Sino-U.S. relations, already troubled by arguments over Taiwan, Tibet, Google and other issues.
It will also help establish a more constructive atmosphere for the meeting of the Strategic and Economic Dialogue, probably in May, and the meeting of the G-20 in Toronto in June, where the U.S. still has hopes that China will offer greater cooperation in “rebalancing” the global economy.
If these steps are not taken, odds are that the U.S. and China will have an ugly year ahead. So far, Beijing seems to be signaling its intentions to respond by Congress’ deadline, while making the noises necessary to contain opposition at home, in which case Obama and Chinese leaders can both trumpet their accomplishments before their recession-wearied populations.
But on the domestic front, China still faces over-investment fed by cheap capital, a fact that seems likely to feed trade war mentalities in many markets.