兰格格：在海一方

China Currency

What do yuant from us?

May 20th 2005
From The Economist Global Agenda

As protectionist sentiment grows in Europe and America, China faces increasing pressure to revalue its currency. Domestic financial considerations are also making a revaluation look more attractive. But the road to a freer regime for the yuan is full of potential pitfalls, and Beijing is reluctant to be seen caving in to foreign pressure

TO HEAR American and European officials talk, you might think China was flooding their countries with toxic waste, instead of affordable consumer goods. Both the European Commission and the American Congress have begun proceedings to protect their citizens from the threat of cheap Chinese textiles. Both are unhappy with the effect of China’s currency peg to the dollar—America because it makes inexpensive Chinese goods even cheaper, and Europe because the euro is having to bear the brunt of the dollar’s depreciation. On Tuesday May 17th, America’s Treasury gave warning that unless China relaxes its peg, it is likely to be classified as a currency manipulator. In Congress, a proposal is afoot to slap punitive tariffs on Chinese goods unless the yuan is revalued within six months. Such moves are sufficiently worrying that on Friday the official Xinhua news agency reported that China would impose export tariffs on its own textiles starting in June, presumably to ward off more draconian measures abroad.

While the political logic of tariffs is clear, the reasons for pressuring China to revalue are less so. China’s currency peg, at around 8.28 to the dollar, is widely believed to be keeping the yuan undervalued by 15-40%, making Chinese exports artificially cheap. But it also subsidises a great deal of America’s profligate spending. In order to maintain the peg, China is forced to buy loads of dollars, which are then dumped into US Treasury bonds, financing America’s hefty deficits. A sudden decline in Chinese demand for Treasuries would raise America’s borrowing costs, curbing Congress’s ability to dole out pork to constituents. Some economists fear that this would push interest rates up sharply enough to cause a sharp contraction in the debt markets (including the mortgages that are fuelling America’s housing boom) and the economy—though this is unlikely, since the Chinese government seems keen to ensure that any appreciation occurs gradually.

China's economy

China's foreign-currency market
Mar 31st 2005
China's exchange rate
Mar 17th 2005
China's exchange rate
Feb 3rd 2005
Revaluing the yuan
Jan 20th 2005
A fair exchange?
Sep 30th 2004

China

America's Treasury publishes its report to Congress “International Economic and Exchange Rate Policies”. The European Commission outlines its relationship with China. The Institute for International Economics discusses the Chinese exchange rate and posts “Adjusting China's Exchange Rate Policies” by Morris Goldstein. The IMF has a paper about liberalisation and the exchange rate in China. See also the People's Daily and China's central bank, the People's

If it is hard to tell whether American politicians are just blustering to impress their constituents or really mean it, it is even harder to tell what effect their remarks are having. The markets are abuzz with talk of imminent yuan revaluation, but such hopes have surfaced many times before, and the Chinese government has so far disappointed. Last week the People’s Daily, an English-language Chinese paper, reported surprisingly specific plans to revalue the currency, only to quickly retract its story, claiming a translation error. However, some observers wondered if the publication had in fact been used by the Chinese government to test the waters.

Certainly, the head of China’s central bank has recently been making noises that sound an awful lot like “revaluation”. But other officials are reluctant to tamper with a peg that they perceive to be working well. This week Wen Jiabao, China’s prime minister, thundered that his country would not bow to outside pressure on the yuan. Indeed, many think that hotter rhetoric from American politicians will only make China delay any revaluation plans it is working on. Having enacted export tariffs in response to protectionist politicians on both sides of the Atlantic, China might now be even more reluctant to relax its peg, for fear of being seen buckling under foreign demands.

Revaluation certainly looks tricky for the Chinese government. It believes that for the sake of political and social stability, it needs 15m-20m new jobs a year. Increases at that level will be enough to absorb population growth, plus displaced workers from the agricultural sector and China’s ailing state-owned firms. And the export sector is seen as a crucial vehicle of job creation.

But this is not the only reason that Chinese politicians are reluctant to revalue. By some estimates, as much as three-quarters of China’s foreign-currency reserves are held in dollars; if the central bank allows the yuan to rise against the dollar, it will also in effect be allowing the value of its reserves to depreciate. Moreover, if slowing the flood of dollars that China’s central bank is pouring into American debt markets does cause those markets—and the American economy—to contract, China’s exporting firms will have worse problems than a more expensive yuan. And problems for those firms could translate into big trouble for China’s frail banking system.

On the other hand, revaluation has its advantages. In order to “sterilise” its foreign-currency operations, preventing them from causing domestic inflation, China’s central bank has been issuing domestic securities. These have been stuffed into the banking system, which may be reaching the limits of its ability to absorb such infusions. Revaluation would ease this problem.

It would also mean that monetary policy could focus more on controlling the money supply, less on maintaining the currency peg. With economic growth hovering close to double-digit levels, fears of an overheating economy, and the attending inflation, are coming to the fore. And because per-capita GDP is so low—only $1,226 in 2004—large swathes of the population are vulnerable to even small increases in inflation; price instability could quickly become political instability. But China’s capital controls and currency peg make monetary policy much harder to execute.

As pressures are growing at home, so they are mounting in America, where all those cheap goods, and cheap loans, are fuelling a buying binge that cannot last. America’s national savings rate has already plunged to razor-thin levels, and each passing month of spending more than they earn leaves households more vulnerable to a sharp rise in interest rates when the Chinese stop lending. Despite the immediate political fallout, it looks like both America and China would be better off taking their medicine now, rather than dragging things out in the hope that a miracle will intervene.

Don't expect too much
But even if China does revalue, it will not be the salvation that American politicians are praying for. First, it is highly unlikely that the yuan will be allowed to rise very far; even optimists expect a revaluation only in the range of 3-10%, which will still leave the currency seriously undervalued.

Moreover, the effects of a relaxed peg on America’s current-account deficit will be extremely modest. China accounts for less than one-tenth of America’s trade, so even a 10% revaluation would only reduce the trade-weighted value of the dollar by 1%—not enough to produce any noticeable change in America’s current account. Nor is it clear that even a big revaluation would help much. Morris Goldstein of the Institute for International Economics estimates that even a 25% revaluation would reduce the current-account deficit by less than 5%.

Nonetheless, China seems to be preparing the way for a slightly freer currency. This week it allowed some foreign currencies to be traded against each other for the first time in China. This is widely seen as a preparation for reform of the tightly controlled currency regime. And if a revaluation seems unlikely to please America’s protectionist politicians, it should nonetheless help to correct the imbalances caused by the gaping American current-account deficit, if only by weaning America’s spendthrift consumers—and government—off cheap Chinese credit. If the hour of reckoning is not quite at hand, it seems only a matter of time before China’s financial system, and America’s borrowers, begin to grow up.

Posted by at May 24, 2005 01:17 PM