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Is China a Currency Manipulator?

Authors: Stephen S. Roach, Chairman, Morgan Stanley Asia Albert Keidel, Senior Fellow, the Atlantic Council Charles A. Kupchan Sebastian Mallaby, Paul A. Volcker Senior Fellow for International Economics Alan Tonelson, Research Fellow, U.S. Business and Industry Council C. Fred Bergsten, Director, Peterson Institute for International Economics
Interviewer(s): Roya Wolverson
April 15, 2010

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The U.S. Treasury Department's decision to delay its annual report on whether to label China a so-called "currency manipulator," originally slated for April 15, highlighted the Obama administration's push to improve U.S.-China relations. The administration--which met with Chinese officials following the report's postponement--considered the delay an important step in efforts to persuade China to let its currency rise in value against the U.S. dollar. However, economists remain divided both on whether the yuan is undervalued and how to best influence Chinese policy on the issue. Some say China has pegged its currency to the U.S. dollar to extract unfair trade advantages with U.S. consumers. Others consider profligate U.S. spending habits and low interest rates to blame for trade imbalances.

In this roundup, Morgan Stanley Asia's Stephen Roach, the Atlantic Council's Albert Keidel, CFR's Charles Kupchan, and CFR'S Sebastian Mallaby all argue the Obama administration was right to postpone its decision. Roach argues that using the Treasury report to influence China's currency policy would deny the United States' own role in creating global imbalances. Keidel, who agrees that the United States shares blame for imbalances, says the notion that China manipulates its currency does not account for countervailing factors such as its partial peg to the euro and its declining trade surplus late last year. Mallaby says China does manipulate its currency, but argues, along with Kupchan, that the United States should work multilaterally to "nudge China" on the issue.

The U.S. Business and Industry Council's Alan Tonelson and the Peterson Institute's Fred Bergsten both believe China manipulates its currency, but they question China's response to the Treasury's postponement. Tonelson says China will evade rebalancing if the United States does not both label it a manipulator and impose tariffs. Bergsten questions whether any independent effort by China to revaluate its currency would go far enough.

Stephen S. Roach, Chairman, Morgan Stanley Asia

I applaud Secretary [Timothy] Geithner's decision to delay the Treasury's foreign exchange report. This effort was in danger of being co-opted by China-bashing protectionists. When laws are twisted for crass political purposes, a responsible government must challenge them. There is a compelling case to suspend, or seriously overhaul, this exercise.

The Treasury report's main problem is it perpetuates the U.S. denial of its own major role in fostering destabilizing global imbalances. The United States doesn't save. The broadest measure of domestic saving--the net national saving rate--has gone negative, falling to a record low of negative 2.5 percent of national income in 2009. But since the United States views saving-short growth as an entitlement, it must import surplus saving from abroad. As such, it counts on the world's savers, such as China, to run large current account and trade surpluses to provide that capital.

The Treasury report's main problem is it perpetuates the U.S. denial of its own major role in fostering destabilizing global imbalances. -- Stephen Roach

China's saving bias and currency management tactics have led to an outsize build-up of foreign exchange reserves--the "ah ha" for China bashers who want Treasury to render a manipulation verdict and Congress to impose trade sanctions. But the bulk of China's foreign exchange reserves are recycled into dollar-based assets, which helps fund the massive U.S. savings shortfall. Who might deficit-prone Washington turn to if it shuts off the Chinese funding spigot? At a minimum, reduced buying by America's largest foreign lender would spell sharp downward pressures on the dollar and/or higher long-term U.S. interest rates--developments that could well trigger the dreaded double dip in the U.S. economy.

China does manage its currency very carefully vis à vis a dollar anchor--a strategy that it believes is essential to protect an embryonic financial system and maintain social stability. But beginning in July 2005, it revamped its foreign exchange mechanism--moving from a dollar peg to a managed float. While this arrangement was suspended during the crisis, senior Chinese officials have given every indication that the hiatus is about to end. This outcome seems all the more likely given the Treasury's delay of the foreign exchange report. And, as a result, the world stands a much better chance of avoiding the slippery slope of trade frictions and protectionism. Thank you, Tim Geithner.

Albert Keidel, Senior Fellow, the Atlantic Council

Treasury citing China for currency manipulation would be a mistake, with flawed economics and long-term damage to U.S. national security. Still, the United States does need to save face for having caused global imbalances. Delaying Treasury's report may help China play along.

America's RMB exchange rate campaign undervalues China's legitimate accomplishments, mistakenly paints China's economic success as "export-led cheating," and buttresses denial of the urgent need for domestic U.S. reforms. "Cheater-China" campaigns also poison vital collaboration opportunities.

Why do so many think China cheats? Because it's plausible. But plausibility isn't sufficient.

China surplus critics really emphasize only one cause--exchange rates. Good economics knows, or should know, that other causes are plausible, too. -- Albert Keidel

What caused China's post-2004 trade surpluses and reserve accumulation? Did a "savings glut" push out Chinese exports? The timing of events shows such logic gets causality backwards.

China surplus critics really emphasize only one cause--exchange rates. Good economics knows, or should know, that other causes are plausible, too. One good story isn't good enough. Let's check the facts. China's global (not bilateral) surpluses were small before 2005. They then became large for two reasons. First, the United States' ever-expanding global spending bubble, from unregulated leveraged debt, sucked out surpluses from many countries, not just China. Second, from 2004 to 2005, China tried to suppress inflationary over-investment after its deadly SARS epidemic. Hence, machinery imports slowed sharply while U.S. bubble spending maintained export growth. China's surplus surged. China's exchange rate did not cause this. It did not cause unbridled U.S. credit expansion or China's 2004-05 domestic investment brakes. America's bubble was the real culprit.

More recently, China did not "re-peg" to the dollar, either. In 2007, China roughly split the difference between dollar and euro trends. But in the 2008 crisis, the euro tanked. Continuing to split dollar-euro trends would have meant RMB devaluation, not revaluation. China did well to hold steady.

Finally, Treasury's citation reference is from July to December 2009, when China's surplus halved. Was that manipulation?

Charles A. Kupchan

The Obama administration was right to postpone a Treasury determination on whether China is a currency manipulator. Despite mounting political pressure in the United States to confront Beijing over the value of the yuan, now is not the time to escalate tensions between the United States and China. On the contrary, after several months of building tension between the two countries, it is a welcome development that both governments now appear to be ratcheting down the antagonism. Washington has eased off on the currency issue; Beijing appears to be ready for constructive engagement on Iran.

[I]t is likely that less U.S. pressure will more readily lead to an appreciation of the yuan than political brinksmanship. -- Charles Kupchan

Moreover, it is likely that less U.S. pressure will more readily lead to an appreciation of the yuan than political brinksmanship. Chinese leaders are not inclined to budge if doing so looks like capitulation to Washington. But they may well move of their own accord when the public pressure dissipates. The appreciation of the yuan is, after all, clearly in the interests of the Chinese government since it will help stimulate domestic consumption and advance a rebalancing of the Chinese economy. Washington is therefore right to address the issue through quiet multilateral diplomacy, not public confrontation.

A key challenge in the months ahead will be managing the domestic politics of U.S.-China relations. Amid sluggish employment, Obama will be under pressure from Congress to address the trade imbalance with China. And to parry criticism of its efforts to engage illiberal regimes, the White House may find itself pressured to take a more forceful stand toward Beijing--especially if Beijing proves unwilling to help tighten sanctions against Iran. Meanwhile, Chinese leaders will face their own pressure from exporters unhappy with the prospect of a more valuable yuan, and from nationalists arguing for a more confrontational stance toward Washington. Leaders on both sides will have to practice deft diplomacy abroad and savvy politics at home.

Sebastian Mallaby, Paul A. Volcker Senior Fellow for International Economics

There is no doubt that China manipulates its currency. On April 14, Fed Chairman Ben Bernanke declared that the yuan is "undervalued . . . to promote a more export-oriented economy," voicing what virtually every economist believes to be the case about Chinese policy. Over the past decade and more, the country's leaders have made a series of political decisions to peg, un-peg, and re-peg the yuan to the dollar, frequently directing the central bank to keep the currency at the desired level by intervening in the currency markets on a vast scale, accumulating enormous quantities of U.S. Treasury bonds. Yet the fact that China manipulates its exchange rate does not mean that the U.S. government has much to gain from saying so. In delaying its statement on whether China is a currency manipulator, the U.S. Treasury has sensibly finessed the issue.

The fact that China manipulates its exchange rate does not mean that the U.S. government has anything to gain from saying so. -- Sebastian Mallaby

Finesse is the right approach because lecturing Beijing on its currency policy is unlikely to achieve the desired outcome. To the contrary, such lectures are seen as an affront to Chinese sovereignty; they trigger a nationalist backlash in China that makes it harder for its leaders to do what the United States is asking. In March, President Obama's mild reference to his desire for increased currency flexibility from Beijing produced a furious response from the Chinese premier, Wen Jiabao, who seemed to feel the need to look tough in the face of foreign pressure. The prospects for a policy shift on the yuan temporarily darkened, though they have brightened a bit recently.

When Obama met China's President Hu Jintao on April 12, he repeated his view that China should adopt a more market-oriented exchange rate. But the better way for the United States to nudge China on the currency is to go through the G20. The undervaluation of China's currency, which is just one of several distortions that orient China excessively toward exports, harms other emerging economies such as Indonesia, Mexico, and Brazil. These countries compete with Chinese exports, which are artificially undervalued because of the manipulation of the yuan. If the rich and emerging economies united in asking China to revalue, it would be harder to dismiss the request as an example of superpower arrogance.

Alan Tonelson, Research Fellow, U.S. Business and Industry Council

Of course President Obama should declare that China is manipulating its currency to seek trade advantages. U.S. law requires such declarations when the evidence warrants. And China has openly admitted its guilt, with Commerce Minister Chen Deming recently acknowledging to the Washington Post that a stronger yuan would destroy typical Chinese exporters' profit margins, and threaten "our own employment and stability."

But the same U.S. law only requires Washington to initiate negotiations in response. A debt-choked United States desperately needing to foster production- and earnings-based growth needs much stronger, faster-acting anti-manipulation measures. So does a president desperately needing more job creation without further boosting astronomical federal budget deficits.

A debt-choked United States desperately needing to foster production- and earnings-based growth needs much stronger, faster-acting anti-manipulation measures. -- Alan Tonelson

More bilateral diplomacy clearly won't work. American presidents have requested progress from China for at least eight years, to no avail save for a 20 percent 2005 to 2008 revaluation whose real effects have been swamped by China's skyrocketing current-account surpluses and vastly stronger national finances. Multilateral approaches are unpromising, too, as a strong global consensus for dealing effectively with China is absent, and international institutions work painfully slowly at best.

Therefore, the United States needs unilateral tariffs to fully offset the artificial price advantages created for Chinese-made goods by currency manipulation. Those tariff policies must be smart and agile, since currency manipulation is hardly China's only predatory trade practice, the individual forms of trade predation are fungible, and some China-based production will migrate to evade country-specific levees. Alternatively, Washington could simplify matters with an across-the-board global tariff such as that implemented by Richard Nixon in 1971, when U.S. finances were in much better shape.

Will such moves require difficult, prolonged adjustments from an import- and consumption-happy American economy? Obviously. But the damage from decades of profligacy cannot be repaired painlessly. And the sooner the United States starts substituting domestic production for imports, the sooner real economic recovery will start, and the sooner the world's still dangerously high structural economic imbalances will begin shrinking.

C. Fred Bergsten, Director, Peterson Institute for International Economics

If China does let its currency start rising again, as widely speculated, the overriding issue is whether it will move quickly and substantially enough. The renminbi is undervalued by about 25 percent on a trade-weighted average basis and by about 40 percent against the dollar. No one expects China to curtail this huge misalignment in a single step. But it needs to both make a sufficient "down payment" to be credible and assure that appreciation will continue until the undervaluation has been eliminated.

China can readily implement such a strategy. It simply has to dial back its massive intervention in the foreign exchange market, a.k.a. "manipulation," which now averages about $1 billion per day. Smaller purchases of dollars by the People's Bank of China mean greater increases in the value of the renminbi. China will undoubtedly continue to manage its "float" to keep the rate from rising faster than it wants, however, which undoubtedly means that it will continue running sizable surpluses and investing in large amounts of additional U.S. Treasury securities.

No one expects China to curtail this huge misalignment in a single step. But it needs to both make a sufficient "down payment" to be credible and assure that appreciation will continue. -- Fred Bergsten

China's best strategy would be to surprise the markets with a one-shot revaluation of 8 to 10 percent and simultaneously let it be known that it would do no more until 2011. This would head off an acceleration of capital inflows, which would occur under renewed upward movements of 0.5 to 1 percent monthly that present speculators with a one-way bet as in 2005-08, and indeed stimulate profit-taking reflows that would ease the conduct of monetary policy. It would represent a sufficient "down payment" to quell external pressure for at least a while. It would of course have to be followed up by similar steps in the next two or three years, which could also be timed to surprise the markets and outwit the speculators. Such a sequence of policy steps would reduce China's surplus to a reasonable level, reduce the U.S. current account deficit by $100 to $150 billion and obviate the need for Treasury to label China a "currency manipulator" this year or in the future.

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