from Follow the Money

Not quite manipulation

May 10, 2006

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The Treasury couldn’t determine that “China’s foreign exchange system was operated during the last half of 2005 for the purpose (i.e. with the intent) of preventing adjustment in China’s balance of payments or gaining China an unfair competitive advantage in international trade.”

Intent is always hard to prove.  And it is a bit subjective.   So it gave the Treasury an out.   

The Treasury decided that this was not the right time to name China as a manipulator.  But the Treasury also stressed that China needs to do more:

“China’s advances are far too slow and hesitant given China’s own needs, and its responsibilities to the international financial community.   The delay in introducing additional exchange rate flexibility is unjustified given the strength of the Chinese economy and the progress in China’s transition.   China needs to move quickly to introduce exchange rate flexibility at a far faster pace than it has done to date.  With a still rigid exchange rate, China lacks effective monetary policy tooks to avoid the boom-bust cycles it has experienced in the past.   Given our strong disappointment and the importance of China to the world economy, the Treasury Department will closely monitor Chinals process in implementing its economic rebalancing strategy”

The US also noted that China’s exchange rate is not just of concern to the US:

“China’s exchange rate policies affect the entire world.  Increased renminbi flexibility would greatly facilitate increased flexibility in other Asian currencies.”

The most interesting part though, at least to me, was the section listing the considerations that led the Treasury to conclude that it could not (yet) determine intent.   The Treasury emphasized quite that the report covered only developments during the second half of 2005 – the period when China formally removed its peg to the dollar and moved toward “a managed floating exchange rate regime.”  We all know that China still has a de facto peg, but the Treasury noted that “the examination period of this Report … is the first that includes the Chinese exchange rate policy change.”  

I think there my be a message hidden in there.   

And in the Treasury's second bullet point.  The Treasury notes that the RMB strengthened by 2.6% against the dollar in the second half of 2005 (setting a benchmark for the first half of 2006?) and that the RMB strengthened by 4.9% against the currencies of all China’s trading partners in the second half of 2005, since the dollar also appreciated.  

The implied message: the dollar is now going back down, so the RMB is now  not only moving less against the dollar than in the second half of 2005, but also is depreciating against a broad set of currencies.   That might be the evidence the Treasury needs to establish intent next time, unless China allows much more flexibility than it has allowed to date.

China’s decision to keep the RMB from rising above 8 over the past few weeks was meant –I think – to send a signal to the US Treasury.   I suspect that my emphasizing China’s moves in the second half of 2005 and the broad RMB appreciation, the Treasury is trying to send a signal as well.

Either that or it was looking for excuses not to name China as a manipulator after threatening to do so last time.

Still, so long as Congress doesn't take manipulation off the books, I don't see how Treasury can avoid a finding of manipulation if it looks at the same set of variables in the fall.  Unless China moves more, of course. 

That puts me at odds with some other close readers of the report, who have focused on the fact that the Treasury didn't use its press statement to issue any explicit  threats.  I think the message of "do more or else" was still there, it was just a bit more subtle.  Holding off with the public threats but setting out criteria that suggest the need for more action may send the right signal ...  and in any case, the real "or else" threat comes from the Congress, not the Administration.

Moreover, after reading the World Bank’s latest China Quarterly, it is hard to avoid the conclusion that there is a strong case that China needs to allow more RMB appreciation to achieve its domestic goals.   Not only is investment growth accelerating, but that investment in the production of tradable goods is growing far faster than other kinds of investment.   Export growth accelerated in the first quarter as well.   Rebalancing will be hard without some price signals.   

The US Treasury has given China a chance to move more without an explicit US threat, at a time when domestic conditions in China call for an appreciation.  I hope China seizes the moment.

(Note: I edited this after initially posting it)

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