THE American authorities have laboured hard for almost four years to persuade the Chinese to change the way they run their currency arrangements. Yesterday’s move suggests that they have at last enjoyed some success but it is far from clear that it will be enough to defuse the mounting economic and political tensions between the two countries.
For several years US policymakers have watched with mounting alarm as American manufacturing competitiveness has declined and jobs disappeared as Chinese imports have soared. In a few years the US trade deficit with the rest of the world has risen sharply and now stands at nearly $700 billion (£400 billion) a year, or 7 per cent of US national income. Yet while the dollar has fallen by more than 10 per cent in the past three years against the world’s major currencies, creating some of the conditions necessary to eliminate at least part of that deficit, it has not moved at all against the Chinese currency.
The authorities in Beijing have held the yuan fixed against the dollar for a decade; that has helped to avoid the loss of international competitiveness that would have happened if the currency had been allowed to rise against the dollar. The Chinese now run a surplus with the US of more than $100 billion.
But it has been bought at the price of rising anti-Chinese sentiment in the US. Earlier this year Charles Schumer, the populist senator from New York, denounced China’s refusal to let its currency rise against the dollar as a breach of the rules of free international trade. He introduced legislation — which immediately attracted wide support — that would impose tariffs on Chinese goods if the currency were not revalued to help to make US goods more competitive.
The American authorities have tried a more softly-softly approach, telling the Chinese that a change would be as much for their own good as for the US’s. Alan Greenspan, the Federal Reserve Chairman, has publicly and privately told the Chinese that holding down the value of their currency for a long period against market forces will lead to a build-up of inflationary pressures at home.
For US officials, yesterday’s development represents a partial victory. The move to a managed float means a sharp break with the Chinese policies of the past decade; and although the immediate effect is small and the longer-term effect is unclear, it looks like another significant step towards the accommodation of China into the global economy. “China’s full implementation of its new currency regime will be a significant contribution toward global financial stability, ” John Snow, US Treasury Secretary, said.
“It’s a very smart move by the Chinese,” said Albert Keidel, a former senior Treasury official in the Bush Administration who handled many of the negotiations with the Chinese in the past few years. “It’s a signal that the (yuan) is no longer going to be fixed to the US dollar.”
The currency in future will be managed, with its value set against a range of other currencies. This is some way short of the free-market approach favoured by the US but, given the domestic economic constraints in China and the risk of rapid speculative inflows of foreign currency into the country, it looks like a sensible piece of economic management.
It is unlikely, however, to lead to any easing in the political pressure in the US. The immediate practical effect of the measures announced yesterday — an upward move of the yuan of just 2 per cent — is well below the kind of revaluation that the critics in America have been arguing for. It is almost certainly going to be insufficient to keep Senator Schumer and his colleagues from ratcheting up the pressure with further threats of tariff protection for US goods.
The immediate practical effect of the measures announced yesterday is well below what the critics in the US have been arguing for. It is almost certainly going to be insufficient to keep Senator Schumer and his colleagues from ratcheting up the pressure with further threats of tariff protection for US goods, though yesterday the Senator welcomed the move as a “good first step, albeit a baby step”.
And things could actually get worse rather than better. By pegging the yuan to a basket of currencies, the Chinese are opening up the possibility that their currency could actually fall against the dollar. In recent months the US currency has risen against the euro and the yen; if that happened under the new arrangements, the yuan would actually decline slightly.
In any case, few serious economists, Mr Greenspan included, think that a substantial increase in the value of the Chinese currency would make much difference to the US current account. Even if the yuan does rise, it is highly likely that US importers will find other places from which to supply their domestic demand.
American fears of the China threat are steadily intensifying, with hostile bids from China emerging for US companies, an escalation in the rhetoric between the two countries over Taiwan and the Pentagon reporting this week that China’s military capabilities are growing rapidly. Yesterday’s historic decision, in other words, looks like good economics — and perhaps shrewd politics by the Chinese. But the diplomatic challenges are not getting any easier.
PEGS: THE QUESTIONS
Q: What is a currency peg?
A: Under a peg arrangement a country generally links its currency to a larger, more stable competitor’s at a fixed exchange rate. Advantages include certainty for exporters, with the currency generally pegged at a competitive exchange rate, and greater certainty for economic policymakers.
Q: How is the peg maintained?
A: To maintain the peg, economic authorities must intervene on the foreign exchange markets. In China’s case, with its yuan held at 8.28 to the dollar, this implied China buying large quantities of dollars to preserve the dollar’s value against the yuan in the face of market pressure for it to rise.
Q: What triggered the decision?
A: A build-up of pressures, both political and economic. US demands for China to revalue its super-competitive exchange rate reached a level where Beijing was threatened by retaliatory action from Washington to curb its soaring exports to America. Also, distortions in the Chinese economy resulting from the peg made it difficult for Beijing to manage booming growth and contain inflation.
Q: Who are the winners and losers?
A: The switch to a managed float with a moveable peg against a basket of currencies makes both China and big Western economies better off. China will have eased some of the pressures on its economic management, while Western economies’ exports will become more competitive. The change also helps to pave the way for a potential reduction in the vast US trade and current account deficits.
