Let no one think the Bush Administration doesn’t occasionally try to have it both ways.
A month ago the Bush Administration ratcheted up the verbal pressure on China. China was ready to change its peg, they declared. The previous strategy of quiet pressure, patience and financial diplomacy wasn’t working; China was getting the message that there was no urgency.
Today, depending on how you want to look at it, the Bush Administration either upped the heat on China by signaling that it will declare China a manipulator the next time, or wimped out. Setting the clock ticking might buy the Administration the ability to push the Congressional vote on Schumer-Graham off until after October. But splitting the difference also risks pleasing no one.
On one hand, it is pretty clear that China’s commitment to its current peg is "preventing effective balance of payments adjustment" -- the key technical criteria for currency manipulation.
On the other hand, it is not entirely obvious the US really wants "effective balance of payments adjustment." Debtor countries usually quite like getting the financing needed to keep running up their debts. Apart from the manufacturing sector, most of the US seems to quite like not paying enough taxes to finance the current level of government spending, cheap imports that keep down inflation and low interest rates that push up housing prices. Real adjustment means shifting resources out of real estate and into the production of tradable goods and services. Right now, not adjusting seems a lot more fun.
Like the Bush Administration, I am of two minds on this issue. (Post continues below)
If spending $300 billion, almost 20% of your GDP (China’s expected 2005 reserve accumulation), to keep your currency from appreciating is not manipulation, then what is? The criteria for "currency manipulation" are not cut and dried; in practice it is always a political judgment. But intellectually, it is hard to see why heavy intervention to defend the current peg was not (or was not quite) manipulation from July-December of 2004; but heavy intervention to defend the peg after January 2005 is manipulation ...
And while not adjusting may be pleasant in short-run, I also strongly suspect that the longer the current real-estate driven expansion powers on, the more difficult it will be for the US economy to ultimately adjust to a world where it cannot import 60% more than it exports. The chances for a soft landing go up if the US starts to adjust now, rather than continuing to defer real adjustment.
Nor have the China hands completely convinced me that quiet diplomacy always is the best way to get China to change. Quiet diplomacy alone may not sway the important entrenched interests in China who cling to the current peg. After all, China as a whole stands to benefit far more than the US from changing the peg. Chinese taxpayers eventually will get hit with a large bill for all this intervention -- intervention that is required to keep China living beneath its current means.
Yet, for whatever reason -- entrenched interests, a cumbersome internal policy process, fear of change -- China has consistently missed opportunities to change its peg when both market pressure and US political pressure has been relatively light. One such opportunity came last summer, for example, after Japan stopped intervening. Another came earlier this year. I don’t think the current mess entirely is a product of the US political process: if China keeps missing chances to act on its own, it has to expect public pressure on it to change will ratchet up.
China is now big: China’s exports totaled around $700 billion at the end of 2004. Two more years of 30% plus growth, and its exports will be above $1150 billion. That is a lot. In 2004, US goods exports totaled $808 billion. Even if US exports grow at 8-9% a year, China will surpass the US in 2006 if current trends continue. And even if Chinese export growth slows to 25% this year and 15% in 2006, China’s exports would still reach $1000 billion in 2006.
Consequently, the growing firestorm of protectionist pressure that China now faces was completely predictable -- both in the US, and even more so in Europe. After all, Europe can say China has intervened massively to push the renminbi down against the euro, not just to hold it constant - after all, the RMB has tracked the dollar down over the past few years. As the Wall Street Journal noted on Tuesday, the result is clear: booming Chinese exports to Europe.
Yet, no matter how strong the substantive case that China is manipulating its currency, there are three important reasons why it is difficult to formally declare China guilty:
1) The consequences of doing so are a bit too extreme: it starts a process that could lead to massive trade sanctions if the initial "negotiations phase" does not lead to a deal. Sanctions risk a trade war - if not worse (financial meltdown). This is an option of the last resort, not the first, second or even third resort.
3) Bilateral pressure -- despite the backstop of sanctions -- may be less effective than multilateral pressure. Unilaterally declaring China a currency manipulator sets up a very direct confrontation between the US and China. One party wins/ one party loses. Saying that China will likely meet the technical criteria for manipulation in six months sets up the same confrontation, but with a longer fuse.
Yet that kind of confrontation may not be in the United States’ interest. China may not want to appear to give in to US pressure, even if a revaluation is in many ways in its own interest. And a potentially nasty confrontation may not help the broader US-Chinese relationship. Moreover, China is sure to note -- quite rightly -- that it takes two to tango. US trade deficits reflect the US savings deficit, not just China’s peg ...
I don’t understand why the Administration has not worked harder to build the case that China needs to adjust its peg for the sake of the multilateral trading and global monetary system inside the IMF. The US is not the only country with a beef with China: this is an example of an issue where a serious, hard-headed multilateral approach might have better served US interests.
The IMF generally has not put a lot of pressure on China (setting aside for a moment the papers put out by the IMF’s research department). The 2004 Board statement on China is not as strong as it should have been, though at least it, unlike the 2003 statement, doesn’t signal that China’s exchange rate peg seems just fine ("Most Directors noted that there is no clear evidence that the renminbi is substantially undervalued at this juncture.") And apart from the Article IV process, there are a range of things the Administration could have asked the IMF to do.
Why hasn’t the Administration spend more time asking the IMF to do more work on optimum levels of reserve accumulation, to set a benchmark for evaluating China’s reserve accumulation? Both Goldman Sachs and the World Bank have done some interesting work on this topic. Why hasn’t the Administration done more to put the responsibilities that go with the right to choose your own exchange rate regime on the global agenda? Demand that the IMF study whether China’s current levels of intervention go against its IMF commitments?
Of course, the IMF could not in good faith just go after China. It also would need to put some pressure on the US to cut its savings deficit. Fair enough -- both surplus and debtor countries typically do need to adjust.
The IMF is not a body set up to impose sanctions, so you could say a multilateral approach lack teeth. True. But that in a sense is good. Right now, the US system of sanctions is so nuclear that it really cannot be used.
Both China and the US have behaved irresponsibly over the past few years. The US, by running fiscal deficits that contribute to its domestic savings shortage. China, by refusing to change its exchange rate regime even as its trade surplus kept growing and the pace of reserve accumulation kept accelerating (Rumors are that China’s reserve accumulation picked up substantially in April ... ).
It generally doesn’t make sense to tie together the currency of an oil exporter and an oil importer. It also doesn’t make sense for the currency of a country with a big and growing trade surplus (China) to be tied to the currency of a country of a country with a big and growing trade deficit (the US). China now has one of the largest trade surpluses (relative to its GDP) of any non-oil exporting country; the US has one of the largest trade deficits in the world ... Yet there is little that suggests that extricating both parties from the current disfunctional equilibrium will be easy.