As the old axiom goes, you should never shout "fire" in a crowded theater. That's the best way to characterize Treasury Secretary Timothy Geithner's cautious September 16 testimony to Congress on China's exchange rate policy. China's policy of tightly controlling the value of its currency has contributed to the substantial widening of the current U.S. account deficit over much of the past decade. Geithner made clear that the administration's frustration with China's policy has grown, stressing that its assessment (one shared by the IMF) is that the renminbi is significantly undervalued. The roughly 1 percent appreciation in the exchange rate over the past week (since the visit of Chairman Lawrence Summers of the National Economic Council) was said to be encouraging, but Geithner was not convinced this signaled a lasting upward move in the value of the renminbi. A sustained appreciation at a pace that would largely erase the currency's undervaluation was needed, Geithner told the panels in the Senate and House.
Notably, the secretary refused to be specific about the administration's intentions on how it would handle the situation if there were not sustained appreciation of the renminbi. Would the next Treasury foreign currency report label China as a currency manipulator? Would the administration support legislation or new ways under existing legislation to directly deal with China's unfair exchange rate policy? Geithner wisely sidestepped these repeated questions in his replies, not wanting to pour gasoline on the fire that has been lit under a growing number of members of Congress.
While the secretary's testimony can be seen as the best response at this stage, time is clearly running out for China to make a credible exchange rate move. Geithner once again used his congressional testimony to emphasize that the prospect of some type of action against China was highly likely.
Secretary Geithner sent a similar message to the Chinese when he testified to Congress on the exchange rate issue in June. Shortly thereafter, they announced a more flexible exchange rate and allowed the currency to appreciate for a few weeks. But rather cynically, the Chinese again fixed the renminbi's value in July and August, seemingly to test U.S. resolve. Geithner's testimony should be seen as a last-ditch effort to get the message across that a change in China's policy is essential.
Whether China will permanently change its policy remains to be seen. If the currency wars with Japan and Korea in the 1980s serve as any guide, the United States may have no choice but to resort to some form of trade sanctions--as it did back then--to hammer home the point that a meaningful change in exchange rate policy is essential (which is a tough thing for any free trade economist to admit).