We all know how much the U.S. is pissed off with China at pegging its Renminbi (RMB) i.e. the yuan to the $ or, at the most, letting it grow at a snail's pace relative to the $ after pegging it against a basket of currencies, instead of allowing it to float freely (subject to economic forces like growth, productivity, forex surplus, interest rate etc.) which would have resulted in a much stronger yuan. US legislators, in retaliation against the manipulation (deliberate undervaluation) of the yuan by the People's Bank of China, are threatening to punish China by imposing anti-dumping and other anti-trade bills to make Chinese imports to U.S. costly. And some time back, Japan and Brazil too resorted to devalue their currency for a short period to promote their exports .
Dominique Strauss-Kahn, the IMF head, views this global situation as a “currency war” and has enjoined China, almost beseechingly, to give up its “policy weapon” of currency. It’s almost like he is saying to China “Look pal, by freeing your currency and letting it climb, your people will benefit by greater purchasing power, better household incomes, less inflation and lead to a better standard of living in your country. Oh, and in the process, it will also help solve the global imbalances and distortions. See, a win-win situation for all!” He is reiterating the same thing at all IMF and G7 meetings now, as if he desperately wants to be heard to the Chinese. But the question comes, what does China stand to gain in keeping the value of its own currency low in the first place? And why the hell is Uncle Sam poking his nose with what China does to its domestic currency and the IMF bitching about China's protectionist mercantile policies? After all, the yuan is “China’s sovereign concern and should not be discussed in international circles” as noted by a few Chinese officials. The thing is, we're living in a global village, and anything China does indirectly affects the global economy, more so, the U.S.
China, being the last stop of almost every manufacturing process that happens in the world, is a purely exports-driven economy and this decades-old Chinese practice of artificially keeping its currency weak unarguably gives it a trade advantage of damn cheap exports. The 3 major problems that U.S. blames China for, are:
1. its huge trade deficit with China ($173.4 billions from Jan 2010 till Aug 2010)
2. the colossal foreign reserves that China has accumulated ($2.6 trillion)
3. the growing unemployment in America due to its shrinking manufacturing industry. (9.6%)
Five years back, pressurized by the mounting international political tension and the straining sino-US relationship, China decided to pour oil on troubled waters by de-pegging yuan to the $, allowing it to rise by 2.1% and then doing the "tortoise-run" with a basket of currencies – steady appreciation, but very slow. They allowed a narrow-margin oscillation of the yuan wrt to $ and the result till 2008 was a net appreciation by almost 22% from its value in 2005. But alas! The Recession struck, thanks to the credit crunch in America, and China, in a natural state of shielding itself from the global meltdown, fell back to the fixed exchange rate regime, again initiating the depreciation process. However, the net effect still stands at a 17% appreciation in the yuan from 2005. But now, China is not willing to bow down to political pressure from the U.S.
China, being the last stop of almost every manufacturing process that happens in the world, is a purely exports-driven economy and this decades-old Chinese practice of artificially keeping its currency weak unarguably gives it a trade advantage of damn cheap exports. The 3 major problems that U.S. blames China for, are:
1. its huge trade deficit with China ($173.4 billions from Jan 2010 till Aug 2010)
2. the colossal foreign reserves that China has accumulated ($2.6 trillion)
3. the growing unemployment in America due to its shrinking manufacturing industry. (9.6%)
Five years back, pressurized by the mounting international political tension and the straining sino-US relationship, China decided to pour oil on troubled waters by de-pegging yuan to the $, allowing it to rise by 2.1% and then doing the "tortoise-run" with a basket of currencies – steady appreciation, but very slow. They allowed a narrow-margin oscillation of the yuan wrt to $ and the result till 2008 was a net appreciation by almost 22% from its value in 2005. But alas! The Recession struck, thanks to the credit crunch in America, and China, in a natural state of shielding itself from the global meltdown, fell back to the fixed exchange rate regime, again initiating the depreciation process. However, the net effect still stands at a 17% appreciation in the yuan from 2005. But now, China is not willing to bow down to political pressure from the U.S.
Chinese authorities, atypically vocal about their stand this time, have several comebacks.
Firstly, they say, re-pegging the yuan to $ in 2008 was a "special" policy to safeguard themselves against the global meltdown.
Secondly, they argue, their trade surplus with the U.S. is due to growing self-sufficiency from its economies to scale owing to the huge surge of industrialization in the last 2 decades, leading to decreasing imports from U.S.; not due to some stratagem against U.S. which gives them an enormous comparative advantage in trade. For instance, they still have to import raw-materials from a few Asian countries with which they do have trade deficits.
And thirdly, the excess of foreign reserves, that the U.S. keeps talking about, is, according to the Chinese (I couldn't agree more), the "hot money" capital influx in China on speculation of an accelerated revaluation of yuan. This is happening as a direct result of a concept which I'd like to call "Converse of the International Fisher Effect", if you will, which goes something like: an expected appreciation of RMB relative to $ might reduce inflation in China, which is likely to pull up the relative interest rate in China , leading to interest arbitrage opportunity for investors.
Ben Bernanke, the Fed Head, recently hinted the likelihood of QE2 i.e. a second bout of quantitative easing (stimulatory monetary policy of the Fed to print money just to buy mortgage-backed securities and government bonds from banks via open market operations, which would lower their yield and lure investors to switch to stocks, thus injecting liquidity, raising the business capital and fueling the economy). The World Bank is apprehensive that this loose-money policy adopted by the U.S. could lead to a capital flight to higher-yielding emerging markets in developing countries as theirs, creating excess liquidity, which would, ofcourse, be short-lived. As soon as the money-flow takes a U-turn, it'll leave behind inflated asset bubbles to rip open disastrously, very similar to what's happened in Japan in the 90s.
Tim Geithner, the U.S. Treasury Secretary, who wants to accentuate more on the currency issue at the G20 meeting to be held in Seoul in mid-November, is inadvertently reminding China of the bitter Japanese experience that followed the 1985 Plaza Accord, which set in motion the creation of a series of property bubbles and its explosion into the so-called Lost Decade in Japan. By the way, the agreement has done practically nothing till date to improve the U.S. trade deficit with Japan, which was its primary goal. The last thing that China wants is having to sign a Plaza II and "cross the Rubicon" the way Japan did 25 years back (when it agreed to let the greenback drop against the yen, indirectly leading to the asset price bubble)
The economic implications of the revaluation of yuan is complex and hard to tell. However, the immediate loser of the yuan appreciation would be the American consumer, no doubt, who used to buy "made-in-China" products so cheap in Wal-Mart, even though it might mean a job for one of his friends at a firm looking to revive its business in the "American-made" labelled goods. Many U.S. industries which are dependent on China for inputs will be hit badly. The cost advantage and total value added will decline drastically. And quite obviously, this currency adjustment will deteriorate the export industry in China on which majority of its population thrives. The most important question that comes up is: While helping to create jobs in America, why should China accept the sudden transfer of the unemployment burden from America's shoulder onto theirs, when most of this unemployment came from the financial crisis that U.S. instigated 2 years back?
The real culprit that the U.S. is conveniently overlooking is its meagre domestic savings, which is inadequate to feed its domestic investments. Americans must learn to stop living off plastic money and minimize usage of resources. Prudent fiscal policies, rather than rash monetary ones will better help U.S. to address its domestic problem. Yuan appreciation is not their only way out, though it will definitely make things easier for them and, at the same time, give a chance to other ASEAN countries to fill in the gap in exports that China would have left, thus scattering the benefits globally.
Let's accept it. America has its own problems, which the politicians are trying to hide under the curtain of the yuan. "It is always easy to have scapegoats" as Mr. Strauss-Kahn rightly puts it.
The real culprit that the U.S. is conveniently overlooking is its meagre domestic savings, which is inadequate to feed its domestic investments. Americans must learn to stop living off plastic money and minimize usage of resources. Prudent fiscal policies, rather than rash monetary ones will better help U.S. to address its domestic problem. Yuan appreciation is not their only way out, though it will definitely make things easier for them and, at the same time, give a chance to other ASEAN countries to fill in the gap in exports that China would have left, thus scattering the benefits globally.
Let's accept it. America has its own problems, which the politicians are trying to hide under the curtain of the yuan. "It is always easy to have scapegoats" as Mr. Strauss-Kahn rightly puts it.
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