Page 3 of
5 The US as leading
currency manipulator By Henry C
K Liu
advocated the use of capital
controls for the weaker economies, of which
Britain expected to become one in the course of
the war. Britain imposed exchange control soon
after World War II began and kept it for four
decades until a new Conservative government
abolished exchange control in 1979.
The
pre-1979 controls on direct investment restricted
sterling-financed foreign investment except where
it had a positive effect
on
the balance of payments. With respect to portfolio
investment, the controls stipulated that purchase
by UK residents of foreign exchange to invest
overseas could be made only from the sale of
existing foreign securities or from
foreign-currency borrowing. A third element of the
controls restricted the holding by UK residents of
foreign-currency deposits as well as sterling
lending to overseas residents. Cross-border flow
of funds was considered neither desirable nor
necessary for domestic economic growth, if not an
outright threat.
China not a currency
manipulator The US Treasury's Report on
International Economic and Exchange Rate Policy,
required by law to examine whether any US trading
partners are manipulating their currencies to gain
unfair trade advantage, has determined in its 2006
findings that China does not so manipulate its
currency. Still, congressional and media
allegations persist that China's continued
resistance to US calls to allow its currency to
rise to reduce trade imbalances with the United
States has distorting effects on global markets
and detrimental effects on US companies and
workers. Such allegations are misplaced, not
supported by either fact or theory. The
distortions have been created by US trade and
monetary policies and their effects on the
exchange value of the dollar rather than by China,
which pegged its yuan at 8.28 yuan to $1 within a
narrow band of 0.03% for a decade, from 1995-2005,
at times above and at other times below market
trends.
On July 21, 2005, after repeated
pronouncements that no revaluation was
economically justifiable or even being officially
considered, China announced a surprise 2%
appreciation of its currency, putting it at 8.11
yuan to the dollar. It also announced that the
yuan would thenceforth be pegged with the same
narrow range to a basket of foreign currencies
that included the dollar, the euro, the yen and
others likely to reflect China's trade
relationships with the rest of the world. The
components and weight of different currencies
within the basket were not disclosed to the
market.
China appeared to be following
Singapore's managed-float model, keeping both
weights and effective bands confidential to allow
maximum flexibility within a narrow range tied to
a reference peg to the dollar. Many saw it as an
obvious diplomatic move to appease misguided US
pressure.
Manipulation involves willful,
proactive volatile changes to profit from
temporary technical market trends against market
fundamentals. A stable exchange rate cannot be
labeled as manipulative any more than a driver
traveling at constant legal speed for long periods
apace with the police car next to it can suddenly
be accused of speeding merely because the police
car slows down from loss of power.
Senator
Dodd cited anonymous "credible analysts" who
allegedly identify the undervaluation of the yuan
by 15-40% as "a very significant cause" of the
loss of jobs in the US to outsourcing. By
extension, for the US to cure its trade problems
that its own permissive monetary and anti-labor
policies have created, China must revalue its
currency upward by as much as 40%, not because the
market demands it, but because the US needs to
reduce its trade deficits. What the US is doing is
asking China to pay for America's own policy
errors.
But the Dodd Committee needs to
understand that such a cure would be worse than
the malady, as it would cause dollar inflation to
skyrocket in the import-dependent US economy,
bringing dollar interest rates up with it, and
pushing the debt-infested Goldilocks US economy
into sharp recession. After all, China alone, at
substantial cost to its own economy, kept the
yuan's peg to the dollar all through the
decade-long Asian financial crisis that began in
July 1997, when all other Asian currencies
devalued in quick order in a frenzied rush to the
bottom.
At both the House Ways and Means
Committee and the Senate Finance Committee
February 6 hearings on the Bush administration's
$2.9 trillion fiscal 2008 budget, Paulson again
asserted that the US has reached a "crossover"
point in its trade with China, with exports to
China rising at a faster rate than imports from
China. China trade has remained a sensitive topic
with congressional members who, faced with
pressure from constituents over jobs lost to
outsourcing overseas, are pushing Paulson for
action to force China to revalue its currency.
Yet the only sustainable way to increase
US export to China is to raise Chinese wages to
increase Chinese consumer demand, not by forcing
China to revalue its currency upward. Currency
revaluation will only produce monetary instability
that will cause deflation in the Chinese domestic
market, thus dampening demand for imports from the
US.
Paulson defends the yen and
criticizes the yuan Testifying before the
all-powerful House Ways and Means Committee,
Paulson defended the recent fall of the Japanese
yen against the euro, claiming the US Treasury saw
no evidence that Japanese authorities had
intervened in currency markets since 2004 to
manipulate the value of the yen. European
officials have been unhappy about the weak yen
because it makes European exports more expensive
and less competitive in Japan and in Asian markets
where the yen is a significant benchmark.
"Some people might not like where it's
trading, but it's my job to support and fight for
free competitive markets, and I believe that the
yen is trading in a competitive marketplace based
upon underlying economic fundamentals," Paulson
said.
The fact remains that the exchange
rate of a country's currency is fundamentally
affected by the interest rate set by that
country's central bank. Whether such intervention
is manipulation is a matter of perspective.
European ministers, particularly German
Finance Minister Peer Steinbrueck, are of the
opinion that the Japanese yen is undervalued as a
result of Japanese monetary policy. But the
mismatch between European Union and Japanese
monetary policies is caused by Germany's
historical phobia on inflation, thus preventing
euro interest rates to reach parity with near-zero
yen interest rates. The low yen interest rate is
beneficial to the EU and US economies, allowing
carry trade, a financial manipulation to borrow
low-interest currencies to lend in high-interest
currencies, to provide funds to finance investment
the high-interest economy. The tradeoff is
payments imbalance from trade.
Currency
peg not immune to market forces A peg of
one currency with another is a unilateral regime.
It does not require permission from the government
of the pegged currency. A currency peg is not
sacred or inviolable, nor is it a free lunch for
the economy that adopts it.
Any currency
peg can broken by the market if the government
that adopts it is unwilling or unable to bear the
cost of sustaining it, as has happened to many
currencies around the world, including the British
pound's peg to the German mark, which was broken
by hedge-fund speculator George Soros in 1992 with
a spectacular profit of more than $2 billion in a
matter of days, draining the exchange reserves of
the Bank of England and precipitating a collapse
of Europe's Exchange Rate Mechanism (ERM).
The ERM was a multilateral
fixed-exchange-rate regime adopted in March 1979
as part of the European Monetary System (EMS), to
reduce exchange-rate volatility and to achieve
monetary stability in Europe, in preparation for
the Economic and Monetary Union and the
introduction of a single currency, the euro, on
January 1, 1999. The ERM was established by the
then European Community to keep member countries'
exchange rates within specific bands in relation
to one another. The purpose of the ERM was to
stabilize exchange rates, control inflation rates
through a link with the strong and stable
deutschmark, and to nurture intra-Europe trade. It
was also designed to enhance European world
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