How revaluing the yuan would help
China By Peter Morici
Not since the United States floated the
dollar in the 1970s and threw the Bretton Woods
system on the scrap heap of history has the
management of exchange rates so captured the
attention of economists and national politicians
as China's undervalued yuan does now.
Then, as now, all manner of polemics and
the weight of established authority argued that
governments should manage currency-exchange rates,
much as they attempt to fix prices, for
example of sugar or
petroleum, supposedly to serve the greater good.
We hear about China's weak financial
system, the pent-up demand for US dollars in
China, and the need for exchange-rate stability in
developing countries. However, we should always be
wary when professors, who enjoy the absolute
protection of tenure, and corporate leaders and
bankers, whose investments benefit from government
meddling in markets, argue that prices should be
regulated in the public interest.
China's
financial system would be no more rickety or
vulnerable if the exchange for the yuan were
maintained at a level more consistent with
underlying supply and demand in foreign-exchange
markets.
As things stand, thanks to
China's huge trade surplus and inward foreign
investment, the international demand for its
currency, the yuan, greatly exceeds the supply. To
limit market appreciation to less than 5% a year,
Chinese monetary authorities print yuan to
purchase US dollars and other hard currencies
valued at about US$300 billion annually.
Otherwise, the value of the yuan against the
dollar would rise at least 40% to about 4.5 from
its current rate of about 7.6 per dollar.
In turn, Chinese authorities purchase US
Treasuries and other securities to earn interest
on their hoard, and sell yuan-denominated bonds
domestically to soak up the excess liquidity these
yuan sales create and head off inflation. This
increases Chinese savings and transfers purchasing
power to, and lower savings in, the United States.
Through this process, Beijing encourages
overinvestment in manufacturing export industries
and excessive urban development, stokes a
speculative bubble in China's stock market, and
provokes inflation in global oil markets.
(Manufacturers in China use energy much less
efficiently than do competitors making similar
products in the West.)
All this causes
underinvestment in Chinese domestic needs, such as
decent sanitation and clean water in rural areas,
and exacerbates income inequality that undermines
the social stability the Communist Party so
earnestly seeks to preserve.
These
processes also exacerbate job losses in
manufacturing and widen economic inequality in the
US and other industrialized countries, thereby
undermining political support for the World Trade
Organization system of free trade that has so
benefited China's economic progress.
One
of the curious accomplishments of the
administration of US President George W Bush and
other defenders of this alchemy has been to label
as "protectionists" US critics who advocate a
market-determined yuan. What a novel idea for a
Republican administration - campaigning for free
currency markets is a protectionist conspiracy!
Equally remarkable, these defenders of
rigged markets have enlisted the conservative
press to ridicule anyone who proposes meaningful
US responses to the harmful effects of Chinese
mercantilism on the US economy.
Clearly,
it would ease Sino-US relations if China revalued
the yuan to, say, 6 or 6.5 per dollar. But once
China revalued substantially, its policy of
woefully slow yuan appreciation would no longer be
credible among investors. Pressure to keep
revaluing the yuan upward would be incessant.
Right now, thanks to the yuan peg and
inward investment, China must purchase US dollars
and other currencies at a pace equal to 10% of its
gross domestic product and about 25% of its
exports. That requires Beijing to work quite hard
to find enough domestic investors to purchase
yuan-denominated bonds to increase domestic
savings by that amount and head off a bout of
liquidity-driven inflation. The policy would
collapse if the government could no longer sell
ever larger amounts of yuan-denominated bonds to
recapture all the yuan it prints to buy dollars
and other hard currencies.
A stated policy
of revaluing the peg to a level that does not
require persistent one-sided intervention through
large purchases of dollars would be credible and
welcomed. Revaluing, for example by 10%,
initially, and then permitting the yuan to rise 2%
against the dollar each month, until one-sided
intervention was no longer required would satisfy
financial markets and permit the necessary
adjustments within the Chinese economy to unfold
in an orderly fashion.
What investors need
to know is what the policy is and that Beijing is
moving the exchange rate for the yuan, in a timely
fashion, to a value that is consistent with
China's growing competitive strengths.
Remember, the exchange rate is nothing but
a price. Sooner or later, when a government fixes
prices, someone gets hurt. Often, many ordinary
working people get hurt the most.
Peter Morici is a professor at
the University of Maryland School of Business and
former chief economist at the US International
Trade Commission.
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