China took an historic step revaluing its currency July 21, but for the American and European hawks, a 2.1% rise just doesn't cut it. They see a 20% to 40% revaluation if the market had its way and have criticized Beijing for a lack of transparency concerning the basket system of currencies to which the yuan is tied.
Clear information as to exactly how the currencies in this basket are weighted – the dollar, yen, euro and won are supposedly dominant – is yet to be forthcoming, and critics have suggested that the "managed float" is just another means of justifying currency movements dictated from above. Yet Beijing remains undeterred by accusations that an "artificially low" yuan is at the root of America's US$144 billion trade deficit with China, and is committed to its "managed float" as a means to transition the renminbi to a market-based currency.
The PBOC may have widened the trading range in November against non-dollar currencies, the yen and the euro, to a 3% maximum from the 1.5% set at revaluation, but this does not affect the yuan's trading band against the dollar of 0.3% per day. The general view is that movements will continue to be minimal, with no repeat performance of the July appreciation.
"The central bank will adjust the floating range of the yuan exchange rate at the proper time based on the market's development and economic, financial trends," Xiang Junbo, vice governor of the People's Bank of China, said last month ahead of US President George W Bush's visit to the country.
Senior officials at Bank of China in Hong Kong, cited in a report by the Financial Times, feel that Beijing will hold the yuan steady for six months, largely due to pressure from domestic exporters and manufacturers.
Pressure from all sides
China's export lobby fears that Asian rivals can produce goods 20% cheaper than Chinese domestic manufacturers in some cases. Indeed, Asia-based economists are sympathetic to this view, arguing that a 20% revaluation could have a disastrous impact on parts of the economy.
"Agriculture would be crushed by the flood of cheap agricultural products," said Dong Tao, chief economist for Credit Suisse First Boston in Hong Kong. "That would lead to social instability. Any country faced with that would act decisively – not just China."
However, Tao does concede that other areas of production, notably manufacturing, "Can probably handle" 20% as costs are so low – and this is what is driving US calls for reform.
Bush faces hostile voters losing jobs in industries that can no longer compete with low-cost China. Factor in Democratic gains in recent state elections and the Republican administration that is under pressure to deliver some good news fast.
The US trade deficit with China reached US$20.1 billion in September, amounting to US$146.31 billion for the year so far. The same month also saw the total American deficit jump by US$66.1 billion, 11.4% higher than the US$59.3 billion imbalance in August. The trade gap is easily on pace to surpass the 2004 record deficit of US$617.6 billion.
The release of China customs figures for October didn't help matters. They showed no signs of a slowdown as the country's trade surplus for the month hit US$12 billion. The total surplus for the first 10 months of 2005 stands at US$80.3 billion, compared to US$32 billion at the same point in 2004.
While angry western manufacturers point to the US-China bilateral imbalance as clear evidence of currency manipulation, economists on this side of the Pacific tend to disagree. Even if the yuan were free to fly, they doubt that it would.
Supporting Beijing's case is the market itself. If the yuan were undervalued, then surely the bulls would be pressing against the ceiling of 0.03% per day. This has not happened. Since July, the yuan has gone up and down within the range.
"In a developing country with a poor financial sector and an underemployed labor force, it is unlikely the currency would rise sharply," said CSFB's Dong Tao.
Pundits weigh in
Andy Xie, an economist at Morgan Stanley, agrees that a rapid appreciation would be unlikely. "The market is expecting very little. China has a serious financial sector problem and a serious labor market problem. Under such circumstances, it's unlikely the currency will be strong," he said.
Kent Yau, deputy research chief at Core Pacific-Yamaichi, doesn't expect much more than a 10% to 15% rise. He feels that arguments suggesting China's high trade surplus is evidence that the yuan is undervalued are "Grossly simplistic" "There are other factors. There has been such an inflow of money because people have been speculating on an appreciation," he said.
Not all overseas experts see the yuan as greatly undervalued at all. The International Monetary Fund believes its current value is not far off the mark, while the US Treasury Department is on record as saying it believes China does not appear to be manipulating its currency to gain unfair trade advantages over the US.
And departing US Federal Reserve Board Chairman Alan Greenspan told the Senate Finance Committee in June: "A revaluation of the yuan would have limited consequences for overall US imports as well as for US exports that compete with Chinese products."
What's more, US Treasury Secretary John Snow praised China's decoupling effort. "They've put in place a mechanism that provides room for significant movement over time in the currency, and they've expressed a commitment to using market forces to let the currency move," he declared.
Republican electoral reverses appear to have turned him more hawkish, though, as he later pressed for a revaluation. This turn-around certainly puts Snow more in tune with political sentiment in the US, where New York Democratic Senator Charles Schumer is sponsoring the tough-talking China Free Trade Bill. Under Schumer's legislation, a 27.5% all-import tariff would be levied on China if its currency does not rise to something approaching 27.5%, a figure based on his notion of the yuan's true value.
However, Jonathan Anderson, chief economist at UBS in Hong Kong, doubts the validity of Schumer's reasoning. "Developed countries complain that the yuan is behind job losses and rising deficits. We don't find evidence to support this," he argued. "The US bilateral deficit is certainly growing, but the US-China balance is distorted by processing and re-export trade. When we adjust for that, China's market share gains are smaller."
Meanwhile, Morgan Stanley's Xie doesn't even think the China Free Trade Bill will come to pass because the US government is bogged down by more pressing issues such as the nomination of a new Supreme Court Justice. "There is so much going on over there," he said. "The issue is only magnified here."
As to the yuan's true value, CSFB's Dong Tao said: "The Chinese currency has been pegged to the dollar for 10 years. After such a long period, its value becomes the fair value, because if it were not, the inflation rate would have had a corrective impact and covered the difference, but that has not happened."
To these Asia-based economists and analysts, no rapid revaluation is expected and, if a larger one is due, it will happen over years, if not decades. After all, the Japanese yen took more than 20 years to rise 30% against the dollar.
How to calculate the yuan's value
There are several methods to establish a market value for a currency that does not trade freely, but the trouble is that they arrive at different results. Worse, practitioners using the same method add individual inputs in their own studies, which create different results again. Nonetheless, they all come up with much higher numbers than Beijing does.
FEER (fundamental equilibrium of exchange rates) – Stresses analysis of inter-currency alignment inconsistencies and Senator Schumer's figure of 27.5% is the midpoint in the Washington Institute's wide range calculation of a 15% to 40% under valuation. Using the same FEER system, though, the big French think tank CEPII (Centre d?Etudes Prospectives et d?Informations Internationales) rated the RMB as 44% too low.
Big Mac Index – The highest number – 59% – comes from the Economist's "Big Mac Index", a half-joking system based on the relative prices of the McDonald's signature burger in every country served.
PPP (purchasing-power parity) – The most quoted high number of 40% comes from PPP, which suggests that over time, exchange rates should equalize the prices in any two countries of a common basket of tradable goods and services.
Econometrics – This system holds that the value of the yuan is best found by measuring a country's productivity growth and budget balances against those of other states, combining that with the value of its foreign holdings. Using this, and its own inputs, Goldman Sachs arrived at a figure of 10%.