Renminbi madness

Despite protests to the contrary by some Chinese officials, there is no doubt that Beijing is manipulating the value of its currency. The renminbi is clearly pegged to the value of the US dollar and, by definition, any non-free-floating currency is being manipulated.

This is not unusual. About 60 nations peg their exchange rates to the dollar, and they aren’t violating any moral, legal, WTO or IMF codes by doing so. Under IMF rules, countries are free to adopt any exchange rate regime, provided they "avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members."

The US Congress borrowed this IMF language when it passed the Omnibus Trade and Competitiveness Act of 1988, a law that requires the Treasury Department to make the now-infamous biannual decision as to whether any of America’s major trading partners are currency manipulators. Only three nations – China, Taiwan and Korea – have been branded currency manipulators. China was the last to be taken off the list, in December 1994.

There are plenty of reasons, unconnected to gaining an unfair competitive advantage in international trade, for a country to manipulate its currency. As far as Beijing is concerned, it is about providing a stable economic and monetary policy environment to support domestic growth and limit uncertainty in investment and trade decisions. Promoting exports is not the primary consideration.

One reason many observers focus on China’s exchange rate is that they mistakenly believe China’s economy is export-led, giving Beijing motivation to manipulate its currency to promote growth. In reality, almost half of Chinese exports are processed with an average 4% of the export price representing value created in China. As such, domestic investment and consumption are the largest contributors to GDP, not exports. And the increase in the US current account deficit with China – it accounted for 63% of the country’s total deficit last year, up from 32% in 2006 – largely reflects the fact that many goods the US previously imported from other Asian countries are now being sourced from China. According to the US Congressional Budget Office, a nonpartisan agency, rising imports from China have come "at the expense of exports from other Asian countries – and not at the expense of goods produced by manufacturers in the US." It notes that renminbi revaluation would alter the geographical distribution of the US trade deficit, but have little effect on its overall amount.

This, in turn, discredits one of the most compelling justifications for pressing China to revalue its currency: that an undervalued renminbi is a significant cause of American unemployment. 

The manufacturing share of total US employment began to decline well before China became an exporter. Productivity growth, driven by investment and new technology, is really to blame: It has allowed manufacturers over at least the past 50 years to match the pace of overall economic growth without corresponding growth in employment.

Studies supporting the theory that Chinese imports have caused the loss of US manufacturing jobs suffer from serious methodological flaws. One is the assumption that imports are identical to goods produced in the US, and thus American consumers would buy the substitute US-made product at the same price of the import; this is clearly not the case. A second error is ignoring the employment associated with imports. When the US imports goods from China, American workers finance, sell, advertise and transport them. In the case of imports of industrial inputs and machinery, American workers use them to create finished goods. Finally, a focus solely on manufacturing ignores the many American jobs resulting from exports of services and agriculture to China. Between 2000 and 2008, exports of services from the US to China increased by 205%, and agricultural exports rose 695%.

I agree with one part of the criticism of China’s exchange rate policy: Gradually moving the rate closer to market levels will help rebalance the Chinese economy.

Usually, "rebalancing" is simply a code word for currency appreciation. But, if used to mean a shift toward an economy where a larger share of growth comes from consumption, then the rebalancing process is clearly underway, albeit gradually. It is this process – not a large, one-off appreciation of the renminbi – that will drive rising demand for American products, building on the trend of 330% growth in US exports to China over the last nine years.

At the same time, I’ve been forecasting since last fall that Beijing will resume currency appreciation by mid-2010. There is no evidence that China has abandoned the exchange rate reform policy adopted in 2005; the government’s decision to suspend appreciation in the summer of 2008 was merely a temporary and rational response to the global financial crisis. 

Beijing has been waiting for three developments before resuming gradual appreciation: a return to strong domestic economic growth, which has been achieved; stability in the US and European economies, which has, more or less, been achieved; and several consecutive months of year-on-year growth in Chinese exports, which returned to positive territory in December.

The export argument is key to selling a resumption of appreciation to the domestic audience. The Communist Party leadership needs to be able to explain that it has resumed appreciation on its own terms and is taking a step that remains in China’s self-interest, rather than simply responding to foreign pressure.

There is no surprise in China’s exchange rate once again becoming a political lightning rod in Washington. The combination of a 190% increase in imports from China since it joined the WTO and a US unemployment rate approaching 10% is a volatile mixture. But surely political leaders in Washington and Beijing, charged with managing one of the world’s most important bilateral relationships, can do better than threatening a trade war over a policy decision that is not a key obstacle to US economic recovery, and that is also not contrary to China’s self-interest.

Members of Congress are responsible for dialing up the rhetoric on the issue, while the Obama administration and the Beijing leadership have been comparatively calm. Delaying the deadline – originally April 15 – for publication of the Treasury’s currency manipulation report is helpful, but it doesn’t offer a lasting resolution.

All sides should consider the following steps.

1) Ignore the pundits. Leaders in Washington should not listen to self-promoting pundits who make ill-informed recommendations. For example, Niall Ferguson, a professor of history and business administration, recently told a Congressional committee that, although Beijing can’t be blamed for the reckless lending and borrowing or the poor regulation that gave rise to the financial crisis, it should be held responsible for a "willingness indirectly to fund America’s consumption and real estate speculation" via an undervalued currency. In my view, it is absurd to hold China responsible for America’s homegrown financial crisis, and equally absurd to argue that renminbi appreciation would solve US economic problems.

2) Washington must consider the timing. The decision to delay publication of the Treasury report was a smart move by the US. Labeling China a currency manipulator would have been a deliberately provocative political act that would have generated an equal and opposite political reaction in Beijing: deferral of the resumption of gradual appreciation. Postponing the report gives Beijing time to take the step the US desires, while avoiding the appearance of submitting to American pressure.

3) Beijing needs to understand US politics. By May, China will have enjoyed six consecutive months of year-on-year export growth, and the domestic economy is clearly well on the road to recovery. Given that the US decided not to tag China as a manipulator on April 15, Beijing needs to reciprocate by resuming gradual appreciation, either shortly before the US-China Strategic and Economic Dialogue in late May, or after that meeting but before the June G20 summit. Failure to resume appreciation this summer will almost guarantee that Obama is forced to name China a manipulator in the near future, probably in advance of the November Congressional elections. That would be a step that serves neither side’s interests.

Party leaders may resent the fact that decisions they consider to be domestic are being hotly debated in foreign capitals, but this is part of the price of China’s global integration, rising wealth, and the fact that their country accounts for 63% of America’s current account deficit.