US-China Exchange Rate Tensions Climb

17 March 2010

Tensions between Washington and Beijing over China's currency policies rose sharply during the past week, as the Chinese leadership and US lawmakers traded accusations of protectionism over the value of the yuan.

A group of US senators announced legislation on Tuesday that would slap extra duties on imports from China if it did not allow its currency to appreciate.

The move followed months of growing calls from US policymakers for Beijing to revalue the yuan (also called the renminbi), on the grounds that its fixed peg against the dollar, in place since mid-2008, was artificially low and thus effectively subsidising Chinese exports. The 14 senators, from both parties, accused China of manipulating its currency, blaming an undervaluation of 25 to 40 percent against the dollar for US job losses.

Only two days earlier, Chinese Premier Wen Jiabao rejected calls for China to revalue the yuan, calling them unhelpful and tantamount to protectionism. Speaking to journalists at the end of the annual session of the National People's Congress, the country's unelected parliament, Wen said that China would "keep the yuan basically stable at a reasonable level."

"I can understand some countries' desire to raise exports, but what I do not understand is depreciating one's own currency and attempting to pressure others to appreciate, for the purpose of increasing exports. In my view, that is protectionism," he said.

Some senior Chinese policymakers had recently suggested that a change in currency policy might be in the offing. Zhou Xiaochuan said earlier this month that the peg of roughly 6.83 yuan to the dollar was part of China's response to the global financial and economic crisis. While he did not provide a timetable for abandoning policies including the "special foreign exchange mechanism," he said it would happen "sooner or later."  Wen's remarks appear to suggest the exit will be later rather than sooner.

Wen's comments came days after US President Barack Obama urged China to allow its currency to rise, in order to reduce global financial imbalances. Obama, who has launched an initiative aimed at doubling US exports in five years, said that "China moving to a more market-oriented exchange rate" would make an "essential contribution" to reducing massive current account surpluses in countries like China, while decreasing large deficits in the US.

The Senate legislation - backed by senators including Charles Schumer (Democrat-New York), Lindsey Graham (Republican-South Carolina), Debbie Stabenow (D-Michigan), Sam Brownback (R-Kansas), and Evan Bayh (D-Indiana) -would establish criteria for the Treasury Department to identify "fundamentally misaligned" currencies, alongside a timeline for increasingly sharp penalties. The penalties would range from withholding support for granting offenders a larger share of votes at the International Monetary Fund to countervailing duties reflecting the estimated undervaluation (the tariffs imposed to offset, or ‘countervail' subsidies).

Schumer and Graham tabled similar legislation in 2004, threatening China with a 27.5 percent tariff if it did not let the yuan rise. China subsequently allowed the renminbi to appreciate by over 20 percent between July 2005 and July 2008, but this did not prevent the US trade deficit from increasing by about a third.

The World Bank and the IMF, which tend to be reticent about criticising countries' currency policies, have both recently suggested that revaluing the yuan would be beneficial both to China and to the global economy.

In its most recent quarterly report on China's economy, the World Bank said that a higher exchange rate would help contain inflation. "The case for exchange rate flexibility and more monetary independence from the US is strengthening," it said.

"The Chinese renminbi has depreciated in real effective terms in tandem with the U.S. dollar and is assessed to be substantially undervalued from a medium-term perspective," said a recent IMF report to ministers from the Group of 20 leading economies.

A very different view came from the United Nations Conference on Trade and Development. In a policy brief released this month, UNCTAD argued that far from shirking its responsibilities to contribute to global demand, "China has done more than any other emerging economy to stimulate domestic demand, and as a result its import volume has expanded significantly."

"Expecting that China will leave its exchange rate to the mercy of totally unreliable markets and risk a Japan-like appreciation shock ignores the importance of its domestic and external stability for the region and for the globe," said the two-page report, titled "Global monetary chaos."

Arguing that restoring balanced trade relations required "policies that address and prevent currency speculation at the global level," UNCTAD called for a "constant real exchange rate rule" under which nominal exchange rates would vary according to inflation differentials between countries. The report acknowledged that introducing such a rule would require "major political commitments and be fraught with technical difficulties," but insisted that it would be feasible given sufficient political will.

The 21st Century Business Herald, a Chinese newspaper, reported last month that the Chinese commerce ministry was ‘stress-testing' labour intensive industries to see how they would be affected by shifts in the value of the yuan. It cited textile industry sources as saying that preliminary findings suggested that each percentage point appreciation in the yuan would reduce net profit margins by 1 percentage point - while net profits in the industry average only 3 to 5 percent.

Nevertheless, Caixin, an influential Chinese business media group, reported today that signs point to a resumption of exchange rate reforms, with a controlled, gradual appreciation of the currency one of the more probable outcomes. Central bank and government policymakers have been exploring different options for exchange rate policy since the beginning of the year, it reported. One proposal calls for "de-dollarising" the yuan and instead linking it instead to a basket of 18 currencies including the euro and the dollar, with each country's weight in the basket linked to its share of China's total trade volume.

ICTSD reporting.

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