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OPINION
Floating the renminbi is a
red herring
By Gerald P O'Driscoll Jr
and Lee Hoskins
US Treasury Secretary John Snow
has urged China to adopt "a flexible, market-based
exchange rate" for the renminbi, or yuan, which is
currently fixed at 8.28 to the US dollar. Flexible
exchange rates can provide benefits to the countries
that use them. In recommending that China float its
currency, however, the administration of US President
George W Bush is wrapping a protectionist policy in
free-market rhetoric.
The administration's real
goal is to make Chinese exports less competitive against
US manufacturers - and that's bad policy for everyone,
especially consumers.
President Bush's political
advisers want to solidify support with US business.
Additionally, they want to prevent Congress from passing
legislation, such as that co-sponsored in the Senate by
Republican Lindsay Graham of South Carolina and Democrat
Charles Schumer of New York, which would impose a 27.5
percent across-the-board tariff on Chinese goods if the
yuan were not floated.
The administration wants
the dollar to fall against the Chinese currency. Its
policy is one of monetary protectionism, in that it
tries to achieve a trade objective by using monetary
policy to change a nominal exchange rate. Just as with
ordinary protectionism, the goal of monetary
protectionism is to restrict imports and stimulate
exports. In our Cato Institute study, "China: Just Say
No to Monetary Protectionism", we detail the pitfalls of
that policy.
The renminbi issue is a red
herring. Many currencies are pegged to the US dollar,
including the Hong Kong dollar. Why haven't US officials
hectored the Hong Kong government on its currency
system? The answer is that, in contrast to mainland
China, Hong Kong allows the free movement of both goods
and capital into and out of the special administrative
region (SAR). Hong Kong is also exemplary in its
adherence to World Trade Organization (WTO) rules.
Certainly, one can question whether China is
meeting all its obligations under the WTO. The United
States may have legitimate trade grievances against
China. The solution is to pursue such grievances
according to WTO rules. Rather than lead by example,
however, the Bush administration has pursued
protectionism in the name of advancing free trade.
Illegal steel tariffs, agricultural subsidies, and the
recent action on Chinese apparel exports are just three
examples.
China's controls on the movement of
capital out of China ("capital controls") are the source
of whatever problem may exist with its nominal exchange
rate. Getting rid of those controls would compel China's
monetary authority to deal with pressure to revalue its
currency. Either a new peg or a free float would follow.
If Chinese leaders were to abandon capital
controls, US protectionists would lose an argument
against China. At the same time, China's central bank
would no longer need to subsidize America's budget
deficits and capital formation through its purchases of
US Treasury obligations. Economist David Hale estimates
that the monetary authorities of China and Hong Kong
have purchased nearly $100 billion of US Treasury
securities (including mortgage-backed securities) in the
past 18 months.
At this time, China is in no
position to eliminate capital controls. Such a policy
move would compel the government to confront the problem
of non-performing loans at its four large state-owned
banks. Cleaning up these loans, estimated at $300
billion to $400 billion, will take years. Perhaps the
government is taking the first steps with its announced
$45 billion bailout of the Bank of China and the China
Construction Bank. A full resolution in the banking
sector would force a downsizing of state-owned
enterprises (SOEs), such as the source of the
non-performing loans. With two-thirds of the labor force
still employed by SOEs, a sudden end to capital controls
would result in social upheaval and political
instability.
The Bush administration does not
want an unstable China, and so will not press the real
economic issue. Calling for China to float its currency
is political rhetoric to salve US domestic political
wounds, not serious international economic policy.
Hong Kong's monetary experience confirms that a
monetary authority can maintain a peg if it forgoes
monetary sovereignty. Under Hong Kong's Currency Board,
changes in the domestic currency supply are triggered by
changes in international reserves. Price stability
cannot be guaranteed under such a system, and five years
of deflation in the SAR are attributable in part to its
monetary system.
It is doubtful whether China
would opt for such a system once it opens both its goods
sector and capital markets. Perhaps after one or more
devaluations, China will float its currency.
The
citizens of both China and the United States will
benefit when China moves closer to a market economy. In
the meantime, the leaders of both countries need to
avoid protectionism in all forms, including monetary.
Gerald P O'Driscoll Jr, formerly a
vice president at the Federal Reserve Bank of Dallas, is
a senior fellow at the Cato
Institute, which supplied this
article. Lee Hoskins, formerly president of
the Federal Reserve Bank of Cleveland, is a senior
fellow at Pacific Research Institute.
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