China's currency manipulation
APPARENTLY not much has changed since my last articles on this topic (April 10, and April 24, 2006). China continues to be branded a market-distorting currency manipulator.
China's exchange rate (XR) was pegged from 1994 until mid-2005 at 8.28 yuan to the US dollar. Under pressure from all quarters, China made a slow transition in 2005 to a policy of loosely pegging the yuan to a basket of major currencies. Since then, the yuan has appreciated against the dollar and XR now stands at roughly 6.83. Throughout this period, China has aggressively intervened to slow down the yuan from appreciating by selling yuan and buying other major currencies (mostly dollars). This resulted in China's massive forex reserves holdings, growing from $403 billion at the end of 2003 to $2.273 trillion in September 2009.
Many believe that China's forex operations amount to market-distorting currency manipulation to make exports cheaper, and imports more expensive, which contributed to its burgeoning trade surplus. Fred Bergsten, (2008) of the Peterson Institute for International Economics, believes that to remedy current "global imbalances," the yuan must appreciate approximately 40% against the dollar. Michael Musa (2008) and Arvind Subramanian (2008) also voiced similar views.
President Barack Obama and IMF Managing Director Strauss-Kahn, on November 12, tried to persuade Chinese officials that letting its currency appreciate would help China in the long run, and would help the global economy recover faster. Beijing listened, smiled, and ignored them.
Strauss-Kahn argued that a stronger yuan would improve the purchasing power of Chinese households, which would prop up the government's drive to make growth less dependent on exports. He pleaded that an undervalued yuan may promote exports in the short run but it may misleadingly encourage higher business investment which may not be viable once the yuan appreciates.
Market experts argue that a stronger yuan would not only help reduce global imbalances, such as America's trade deficit, but also benefit China. It would help retain control of its monetary policy. By pegging to the dollar, China is, in essence, importing America's monetary policy, which is too expansionary for China's fast growing economy (The Economist, Nov. 18).
If a stronger yuan is in China's own interest, why does it resist? Beijing claims that the yuan has been rising since the beginning of 2008. Its monetary and fiscal stimulus and domestic demand have contributed an incredible 12% to GDP growth this year, while net exports took a 4% bite out of GDP. In the BOP account, current-account surplus has declined nearly 6% of GDP from 11% in 2007. Add to these a near 14% falling of exports for the last 12 months. So, China is not yielding to the currency appreciation pressure -- at least not for now.
It's true that China's recovery rally is moving much faster than all other rival economies; the growth rally is still not yet seen as self-sustaining, but rather continues to be stimulus-driven. China needs American consumers to sustain its growth trajectory and, with persistent decline in recession driven exports -- and numerous factories closed -- China is indicating that any upward yuan adjustment is a long-term consideration.
Beijing favours a gradual appreciation of the yuan. However, an upward revaluation of the yuan by 25% -- which experts believe might eliminate global trade imbalances -- would be politically untenable, because that would put many exporters out of business overnight.
Let's see how China benefits from its undervalued currency. Having the yuan undervalued, say 25%, amounts to an indirect subsidy of 25% to Chinese exports and a 25% tariff on imports. That puts exports from the US, EU and Asian competitors at a huge disadvantage. Obviously, the adjustment of China's non-marker driven currency "misalignment" would benefit Bangladesh and all other countries whose currencies are tied to the dollar.
The equivalency of the yuan's undervaluation, with export subsidy and import tariff, has recently caught up with politicians on both sides of the Atlantic, who're now asking for punitive measures by the WTO. For example, President Obama asserted in October 2008 that China's trade surpluses were the direct outcome of the manipulation of its currency's value. He concomitantly pledged to "beef up U.S. enforcement efforts against unfair trade practices." Former EU Trade Commissioner Peter Mandelson expressed similar views on various occasions.
High unemployment and slow recovery makes trade with China a volatile political issue in the U.S. The Congress has been urging the Treasury Department to bring a formal complaint to the WTO to treat China's alleged currency manipulation as an act of dumping that would permit US imposition of antidumping or counteracting duties on Chinese imports.
Robert Staiger and Alan Sykes (January 2009) argue that to win such complaints with WTO would involve a conversion of the magnitude of China's XR "misalignment" into equivalent real trade imbalances vis-à-vis export subsidies and/or import tariffs. That would provide the WTO with the actual assessed value of unfair trade imbalance "either to identify the appropriate response by the WTO itself or to assess the WTO-consistency of unilateral responses."
Currency manipulation -- as defined in the surveillance provision of the IMF's Article IV -- refers to "protracted large-scale intervention in one direction in the exchange market." China has consistently been violating the provisions to keep the yuan artificially undervalued and gain undue mercantilist export advantage. The time is now for the WTO to punish or exonerate China for its alleged market-distorting currency manipulation.
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