The road ahead for the renminbi
By maintaining a fixed yuan-dollar rate (see Exchanging stability), China has subcontracted much of its monetary discretion to the US Fed in return for the benefits of exchange rate stability. For more than a decade, this has served the world economy well, leading to an explosion of trade, cheaper goods for Americans and prosperity for millions of Chinese.
From a peak of 11% of GDP in 2007, China’s current account surplus declined to only 6% in 2009. Since the world credit crisis broke out, imports have risen faster than exports (Growth booster). China has been importing heavily to boost its infrastructure.
In a 2006 paper, Stanford University economist Lawrence Lau found that Chinese value-added accounted for only about 37% of the total value of US imports from China. In 2008, US International Trade Commission economist Robert Koopman, along with economists Wang Zhi and Wei Shangjin, found the figure to be closer to 50%.
According to a 2007 study by Greg Linden, Kenneth L Kraemer and Jason Dedrick of the University of California, Irvine, each Apple iPod costs $150 to produce, just $4 of which is Chinese value-added. Yet, when the iPods are imported from China, the full $150 is counted as imports from China, artificially adding to US trade deficit. Consider the economic costs US would inflict by imposing trade sanctions on China: how many fewer iPods, iPhones and iPads Apple would sell, how many fewer jobs in production, sales and R&D there would be, and how smaller markets for music, video downloads and car accessories would there be.
International Monetary Fund’s (IMF) Articles of Agreement prohibit countries from manipulating their currency to gain an unfair trade advantage, but the IMF has no powers to coerce China, which does not borrow anything from it. World Trade Organization (WTO) is the forum for developing new multilateral rules. Undervalued exchange rates are de facto protectionist trade policies because they are a combination of export subsidies and import tariffs. Export subsidies and import tariffs are individually disciplined in the WTO but their combination in an undervalued exchange rate is not. At the same time, Chinese producer price and consumer inflation is rising sharply. Hence, a stronger currency might be a good way to stop overheating.
One proposed alternative is for China to move to a crawling peg, with a modest revaluation. But that would invite more pressure on the yuan, as global hot money and currency speculators anticipate a further yuan rise. The People’s Bank of China, with $ 2.5 trillion in dollar reserves, continues to buy US Treasury bills or Fannie Mae securities, leading to misallocation of resources. A solution would be to make the yuan convertible. This is how Germany recycles its trade surplus.
China has learned from the experience of Japan — which bowed to similar US currency pressure in the 1980s and 1990s — revaluing the yen from 360 to the dollar to as high as 80 in 1995. The result was domestic deflation in Japan and its lost decades of growth. In 1971, John Connolly, then US Treasury secretary, told his European counterparts that the dollar was “our currency, but your problem”. The tables seem to have been turned.
The recent visit of the incumbent US Treasury secretary Tim Geithner to Beijing and his decision to delay a report to Congress on whether to label China as a currency manipulator has led to hopes that Beijing could move to a Singapore-style managed float mechanism that regulates the renminbi against a basket of currencies. There could be an inherent appreciation bias in the form of an upward nominal exchange rate slope that could be manipulated according to the stage of the economic recovery.
The correlation with the renminbi for the six months after the 2.1% appreciation of the renminbi against the US dollar on July 20, 2005, was highest for the Singapore dollar, the South Korean won, Taiwan dollar and yen.
The revaluation of the renminbi could make the exports of these Asian countries to China cheaper and trigger further appreciation in their currencies (already up against the US dollar this year). The Indian rupee could join the party this time.