The row over China’s exchange-rate policies is once again heating up ahead of the US Treasury’s April 15th decision on whether or not to brand China a “currency manipulator”. China invariably bristles at being lectured that an artificially weak renminbi gives its exporters an unfair advantage and is contributing to global economic imbalances. Yet even a more sophisticated and less confrontational argument—that currency liberalisation stands to benefit China as much as the rest of the world—would only be likely to persuade the government to reform the exchange-rate regime on its own terms.
The political momentum behind US efforts to force China into changing its renminbi policy has increased ahead of the April 15th Treasury report. Some 130 members of the US Congress have signed a letter calling for the administration formally to declare China a currency manipulator. Meanwhile, a group of senators led by Chuck Schumer (a Democrat from New York) and Lindsey Graham (a Republican from South Carolina) has proposed legislation that could lead to the US bringing cases to the World Trade Organisation (WTO) against countries that refused to address “fundamentally misaligned” currencies.
It is unsurprising that concern about trade with China has risen in the US during the recent recession. With unemployment in the US at close to 10%, concerns about jobs being lost to China are acute. China’s renminbi is still essentially pegged to the US dollar. Given a strong market consensus on the need for appreciation, this suggests that the Chinese authorities are indeed manipulating their currency to keep its value down. Yet although the risk of retaliatory or protectionist steps by the US government has risen, the likelihood is still that the tag of “manipulator” will be side-stepped, and that Messrs Schumer and Graham will have about as much luck with their latest legislation as with their previous (unsuccessful) efforts to impose a 27% tariff on imports from China unless the renminbi was allowed to appreciate.
There are two main reasons why the US administration will probably opt to maintain the status quo, despite vocal calls from domestic lobbies for stronger action against China. The first is that, while the US has a huge trade deficit with China (US$199bn in January-October 2009 according to the IMF’s direction-of-trade statistics), those providing the imports are not just mainland Chinese firms. According to Chinese customs data, foreign-invested enterprises produced 54% of the country’s exports in 2009. Admittedly most of these firms are not formed by investors from the US, but China-based producers are a key part of the supply chain for major US manufacturers and retailers. Imposing measures targeting goods from China would cause significant disruption to US businesses. Most would eventually be able to diversify their sourcing to other low-cost bases, but it is unlikely that many would turn to US-based manufacturers, so the job benefits for the US would be minimal. Just as importantly, prices for US consumers would be pushed up—especially in the short term.
The second reason why US administrations have repeatedly ducked a negative verdict on China’s currency-manipulator status is the difficulty of forcing China to adjust its policies. Delivering such a decision would merely commit the US to negotiations with China to address the issue (either bilaterally or under the IMF), but it is hard to see that these would be more effective than existing exchanges like the Strategic and Economic Dialogue between the two countries. Without WTO approval, more radical steps like tariffs could risk contravening international trade rules. However, winning a decision from the WTO that China’s currency policy represented an unfair export subsidy would be difficult and might take years. In the meantime, relations with China would be severely undermined, compromising the US government’s efforts to gain its support for other policy goals such as preventing Iran from gaining nuclear weapons.
In this context, present calls for a substantial appreciation of the renminbi are looking increasingly misguided. Currency valuation is, at the best of times, an uncertain science. Proponents of appreciation usually point to China’s huge current-account surpluses as evidence of fundamental misalignment. Yet it is peculiar that demands for appreciation have stepped up even as China’s current-account surplus has fallen sharply, from US$426bn (9.6% of GDP) in 2008 to US$284bn (5.8%) in 2009. True, last year was an unusual one, but the Economist Intelligence Unit expects the surplus to continue to fall in 2010, to US$279bn (5% of GDP). We also expect the surplus to continue to fall, as a share of GDP, in 2011-12, even though it will rise again in absolute US-dollar terms.
In any event domestic economic developments in China will gradually alter the terms of the debate. China’s domestic demand continues to expand at a pace far above that in its external markets, and as it finds it ever more difficult to obtain raw materials from domestic sources its growth is becoming increasingly import-intensive. Coupled with this, import prices are likely to rise far more quickly than export prices in 2010, boosted by a surge in oil prices and industrial raw-material costs. Meanwhile, domestic input costs—particularly for land and labour—are climbing rapidly, leading to an effective rise in the cost of production in China, even without renminbi appreciation.
All this is not to deny that the renminbi is undervalued against the US dollar, but the extent of its undervaluation may be less clear than many suppose. It would thus make sense for foreign critics of China’s exchange-rate policy to frame their arguments less in narrow terms of the need for appreciation, and more in terms of the need to liberalise the exchange rate. The hard line implicit in US lawmakers’ calls for China to be branded a currency manipulator risks strengthening the hand of those in the Chinese policy establishment who oppose exchange-rate reform. It is naïve to suppose that a more nuanced US position would have a big impact on accelerating the reform process, and it is clear that China’s domestic priorities will largely dictate the timing and nature of exchange-rate liberalisation. Nonetheless, phrasing the argument in terms that emphasise the positive domestic implications of reforming the exchange-rate policy rather than the advantages to foreigners won’t do any harm. It may also create more leeway for compromise on other issues—whereas an intensifying trade spat could set the reform process back further.
Exchange-rate liberalisation also makes a good deal of sense within the context of China’s broader policy aspirations. China’s efforts to encourage greater use of the renminbi internationally and to develop Shanghai as a global financial centre require a relaxation of currency controls. And China will be unable to reduce its rising exposure to the risks associated with piling up its holdings of US Treasuries so long as the peg to the US dollar is maintained. On top of this, a stronger currency—the likely result of liberalisation—would make China’s imports of strategic raw materials cheaper, which could offset the negative effect of renminbi appreciation on exports. It would also help with China’s goal of rebalancing its economy more towards domestic consumption.