Chinese currency manipulations and global economy

CHINA, Malaysia, and Saudi Arabia are the three major trading partners of the US that maintain a conventional fixed exchange rate (FER) regime. By nature, FER regimes entail frequent intervention by Central Banks to maintain the relative value of the domestic currency close to its parity value. Because of the size of its economy and magnitude of its global trading, China's undervalued FER is breeding undesirable distortions and persistent imbalances in current accounts among countries and between trading partners.

The core question is what constitutes currency manipulation and is China a currency manipulator? In this context the following points merit highlighting:

--Under the IMF rules, a country can "fix," "float," or adopt a wide array of transitional exchange rate regimes and is permitted to intervene when mediation is warranted to offset erratic market fluctuations. Currency manipulation, as defined in the surveillance provision of the IMF's Article IV refers to "protracted large-scale intervention in one direction in the exchange market." China has consistently violated these provisions to keep the yuan artificially undervalued and gain undue mercantilist export advantage. Estimates of China's currency purchases run between two and three billion dollars per day.

--Exchange rate manipulation depends on how a country's real (inflation-adjusted), trade-weighted exchange rate fluctuates against the backdrop of its overall balance-of-payments (BOP) position.

-- China's nominal exchange rate has been fixed at roughly 8.28 yuan per US dollar since 1994. Morris Goldstein (Institute for International Economics, December 9, 2003) argued that: "US dollar has been falling on a real trade weighted basis over the past 20 months or so, and that real, trade-weighted value of the renminbi has been falling along with it -- and this at a time when China has been running surpluses on both the current and capital accounts in its balance of payments and has been experiencing very large increases in international reserves." These surpluses and reserves would call for an appreciation of real exchange rate, not depreciation.

-- After upward revaluation of its currency in last July from 8.23 to 8.11, Beijing indicated that it would abandon the peg and reference movement in the yuan against a basket of currencies (for example, dollar, yen, euro, Korean won, etc). Even then the yuan index has been moving in tandem with the dollar index. As of March 28 and April 6 it was trading at 8.0212 and 8.0098 yuan per dollar. The 8.0098 is the highest appreciation in 12 years. This steady relationship is due to the constraints of the daily range of plus or minus 0.3% in dollar-yuan fluctuations compared to the previous exchange rate announced daily by the central bank of China.

--China has a very restricted foreign exchange market. Even though it allows "convertibility" in the current account, the capital account is "non-convertible." This means Chinese citizens cannot legally convert their enormous holdings of yuan-denominated deposits into dollar-denominated assets. I advance two plausible reasons behind this "non-convertibility” of yuan stance: (a) to keep dollar-yuan exchange rate fluctuations under control and (b) to keep currency speculators off from making a market for yuan.

The above discussions make China culpable of currency manipulation. Its obsessions with the "peg" by resorting to various deceptive tricks is guided to make exports to the US cheaper, and imports to China more expensive, which contributed to its burgeoning trade surplus.

On March 28, the state-run China Business News reported that the mainland's reserves hit $854 billion in February, outstripping Japan's reserves of $850 billion for the first time. In 2005 China's trade surplus with the US was $202 billion. The January trade deficit with China was $17.9 billion, up from $16.3 billion in December. During his visit to China US Commerce Secretary Carlos Gutierrez on March 28 called upon China to

-- open its markets to give foreign competitors the same market access that Chinese exporters enjoy abroad,

-- stop currency manipulation and instead adopt a more flexible market determined currency value and

After the initiation of economic reforms in 1979 China's economy grew at a record average growth rate of 9.7%. Given this gargantuan growth, many economists contend the yuan may be undervalued by 15% to 40%. This translates effectively into a 15% to 40% subsidy to Chinese exporters, providing a nearly insuperable price advantage over US and many European producers (and Bangladesh).

Since Chinese and the US exporters compete in many of the same markets worldwide, US goods fail to benefit from the export price advantage when dollar slides downward because of the co-movement of the dollar and the yuan. The co-movement phenomenon, as I ascribe it, implies that as US prices fall, so do the prices of the Chinese goods (and vice-versa) they are competing against.

China is holding a significant part of its massive reserves in US bonds and other assets. A January 2006 estimate indicate that it held $262.6 billion in US Treasury Securities making it the second largest single investor after Japan. By propelling demand for US Treasuries (keeping bond prices high), China has helped to keep market interest rates lower in the US economy. But China's currency manipulation through unremitting intervention to keep the yuan undervalued, the gaping scale of its trade surplus with the US, and the rising concerns over the leverage being built through its holdings of US assets are drawing strings of frictions with Washington. The result is:

-- The US and the EU on March 30 filed a trade case contending that China is imposing high taxes on imported auto parts contravening commitments made prior to joining World Trade Organization (WTO) in 2001.

-- Senators Charles Schumer and Lindsay Graham proposed a bill to impose 27.5% tariffs on Chinese imports to the United States unless Chinese currency dispute is resolved. The Bush administration strongly opposed this bill.

-- An alternative bill with milder sanctions is now being reviewed by the administration which would require the Treasury Department to determine whether the yuan of China or currency of any other country is "fundamentally misaligned." The sanctions would include US vote against loans from WB, IMF, and ADB and so on.

Over the last four weeks the dollar-yuan exchange rate has shown a bit more volatility, making market watchers conjecture whether Beijing was blinking to appease the US Senators. Maybe not, as David Cohen (Asia, March 28) argues that bigger moves had come on days of wide swings in the dollar in worldwide markets -- when Beijing might have tolerated more movement in dollar-yuan to limit the swing vs. the overall index of the unspecified basket of foreign currencies. .

Many economists recommend China to tolerate continued gradual appreciation of approximately 5% over the course of this year. Such a move is not as striking as the 50% or so appreciation of the Japanese yen soon after the 1985 Plaza Accord. It is further argued that by simply maintaining the 0.3% trading band per day, the yuan could appreciate by as much as 20% during a single quarter. But the Asian Development Bank on April 6 predicted that China's currency may appreciate by only 3% this year. It appears that Beijing is content to ride on the current stance of a snail's pace gradual currency appreciation.

The European Commission backed China's gradual approach rebuffing US calls for speed up steps to boost the yuan. "An abrupt de-pegging of the renminbi, and possibly other Asian currencies, from the dollar could give rise to a sudden reversal of Asian capital flows into the US, which might risk an excessive additional downward movement of the dollar against the euro," said the commission document, which was prepared for an April 6 meeting of European finance ministers in Vienna.

Blame the US as one might, notwithstanding that the Bush administration has worked assiduously on this issue for years. But China has responded with lip service while showing virtually no gesture until recently to revalue its currency. China's emergence as a manufacturing powerhouse at the expense of the US raises economic security concerns and the question whether a country that loses its ability to produce tangible goods will long remain an economic power. How long can the US play on an uneven playing field is a question raised in professional and business circles.

Dr. Abdullah A. Dewan is Professor of Economics at Eastern Michigan University.