A currency to fight
for By Zhou Jiangong and
Jing-dong Yuan
Under increasing pressure
from the United States and from domestic economic
problems mainly caused by excessive liquidity,
Chinese officials are weighing various measures to
reduce the growth of the country's trade surplus.
Beijing may let its currency, the yuan,
gradually appreciate by allowing a broader
floating band for its exchange rate, but there is
little likelihood of any immediate or drastic
action.
China's total trade surplus was
US$22.5 billion in May, up 73%
over
May of the previous year, making the financial
system awash with cash.
In the latest move
by US lawmakers to address China's trade surplus
with the US - a record US$232.5 billion in 2006 -
they introduced legislation in Congress on
Wednesday that would punish countries that
manipulate their currency for unfair trade
advantage. The US Treasury Department on Wednesday
agreed that China's currency is undervalued, but
declined to label China a "currency manipulator".
Many in the US argue that the yuan is
deliberately undervalued by as much as 40%, making
Chinese goods artificially cheaper and
contributing to the US trade deficit with China.
The planned US legislation is clearly
intended to tap into international pressure. There
is a "growing international unhappiness about
China's exchange rate policy," wrote Pieter
Bottelier, the former chief of World Bank mission
in Beijing and a current economic professor at
Johns Hopkins University, in an article for China
Business News, a leading business newspaper based
in Shanghai.
At the same time, in its
semi-annual report on the international economy
and exchange rates, the US Treasury noted that
China's and the world's stake on the yuan had
never been higher.
"Heavy intervention by
China's central bank has led to excessive
accumulation of foreign exchange reserves and a
quick increase in domestic liquidity, which
increases the risk of overheating, a build-up of
non-performing loans leading to banking sector
stress, and asset bubbles. This trend clearly
increases the risk of a renewed boom-bust cycle,
which would be quite harmful for the global
economy," says the report.
The planned
bill also underlies congressional disillusionment
over the effectiveness of the Bush
administration's current trade policy toward
China, ie, engagement via the US-China Strategic
Economic Dialogue (SED), the bi-annual process
that has become gatherings of economic
heavyweights of the world's largest economy and
its fastest growing one.
Indeed, critics
of the administration policy could point to the
modest progress made at the second round of SED
session last month in Washington in which the
currency issue was discussed without any
breakthrough.
So what to
do? China's Premier Wen Jiabao this week
reiterated to cabinet members his concern over
excessive liquidity and "too much trade surplus".
Decision-makers are clearly aware of the damage to
the economy by the excessive trade surplus and
ever-growing foreign exchange reserves. Indeed,
giving the yuan more flexibility might be more in
the interests of China than in the interests of
the US.
Inside the circle of trade-related
central government departments in Beijing, there
is agreement on a so-called "neutral trade
policy", but how to attain the goal seems
extremely difficult and at times emotional.
Wen pledged to increase imports and
contain exports by scrapping tax rebates for
exports enjoyed by pollution-causing and
recourses-costing goods.
Wen appears to be
trying every policy instrument except a dramatic
appreciation of the yuan, that is, using fiscal
and monetary policy instruments that curb
excessive liquidity and expanding channels to
spend foreign exchange reserves and to facilitate
the outflow of capital.
Some economists
have also recommended sharp increase in salaries
for Chinese workers, which would have the same
effect in terms of raising the cost of China's
manufacturing.
Ultimately though, China
might have no alternative but to accelerate the
appreciation of the yuan. To keep its
international credibility, analysts suggest that
China should refrain from intervening in the
foreign exchange markets and thus the yuan will
appreciate faster until the market thinks it's
enough.
The dangers of doing this are
fears that a fast appreciation would kill the
country's export-reliant industries, resulting in
skyrocketing unemployment that would jeopardize
the country's economic and social stability.
Looking for a fight? The
sponsors of the bill presented to Congress on
Wednesday are confident that it will pass with a
veto-proof margin. Specifically, it would require
the Treasury secretary, in consultation with the
Federal Reserve Board chairman, to issue bi-annual
reports that review, evaluate and analyze currency
markets, currency intervention policies of the
US's major trading partners, identify and
determine so-called fundamentally misaligned
currencies, and develop a priority list for
actions.
While Senator Charles Grassley,
one of the sponsors, indicated that the bill was
not intended to start a fight with China and hoped
that the Chinese government would get the message
and begin adjusting its currency policy, the bill
threatens exactly such a fight.
A Chinese
Foreign Ministry spokesman warned against
politicizing bilateral economic issues and using
pressure to settle disputes. But so far Beijing's
response has been firm yet measured.
Meanwhile, the issue has become
politically charged as the 2008 presidential
election approaches and as a Democrat-controlled
Congress is more willing to contest the
administration's China policy, including its
handling of the currency dispute.
The
coming months will determine whether the two
countries are headed for a showdown or whether
Beijing and Washington could find a mutually
acceptable solution to head off a crisis. Judging
by the way past looming crises and trade wars were
averted, an 11th-hour compromise is not out of the
question. However, this will require both sides to
make adjustments, and unilateral action could only
exacerbate the already tenuous situation.
The Bush administration is likely to
continue resisting congressional pressure over
China for pragmatic economic, but also for
important geostrategic reasons. China continues to
present as an alluring future market and has over
the past few years become one of the largest
importers of US goods and services, which
registered more than $50 billion last year and
continues to grow in double-digit rates. China's
financial and service sectors offer potentials
that US companies can ill afford to ignore, while
a trade war would likely lead to retaliation
against American business interests.
Nor
does Washington want to see a trade tussle derail
productive cooperation with Beijing on issues
ranging from North Korea's nuclear disarmament,
Iran, the global "war on terrorism" to global
warming and the disaster in Darfur, Sudan, where
China could exercise measurable influence.
But the administration cannot fight the
bill alone and it needs help. In this regard,
Beijing could do itself a big favor by
demonstrating - if not implementing outright - its
willingness to allow greater appreciation of its
currency that addresses the need to restructure
its economy for long-term sustainability and
averts a head-on collision with a galvanized US
Congress determined to pick a fight.
Zhou Jiangong is a
Shanghai-based analyst on China's economic,
political, and foreign affairs.Dr
Jing-dong Yuan is the director of the
education program at the Center for
Non-proliferation Studies and an associate
professor of international policy studies at the
Monterey Institute of International Studies.
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