Currency manipulation and taka

According to a report by the Congressional Research Service (CRS) Chinese exports to the United States as a share of total Chinese exports grew from 15.3 percent in 1986 to 32.0 percent in 2005.

This stunning export growth was manipulated by pursuing a policy of fixed exchange rate of its currency, the yuan (also called renminbi) with the US dollar and keeping the yuan undervalued at 20% to 40%. Other Asian governments (for example, North Korea, Taiwan, Malaysia, and Thailand) also maintain their currencies in conformity with Chinese currency, lest they lose competitiveness in US and European markets. This currency manipulation translated effectively into an equivalent amount of subsidy to Chinese and other Asian countries exporters -- a nearly peerless price advantage over US and many European producers.

Since Chinese and US exporters compete in many of the same markets worldwide, US products do not benefit from export price advantage when dollar slides downward because the yuan also slides down by the same percentage. The US Commerce Department reported on March 14, 2006 that the 2005 current account deficit (CAD) reached $804.9 billion (which hit $854 billion in February).

A recently decline of the dollar against non-Asian currencies slowed growth of US imports, but export growth remained quiescent because depreciation of the dollar was not large enough. The dollar has only fallen 11.6% since 2002. The desired export growth relative to imports is achievable if the dollar falls by at least an additional 30% to 40%. The policies of Asian governments to keep the dollar overvalued to promote their export-driven growth strategies are the strongest barrier to desired dollar depreciations.

Basic trade theory tells us that each dollar spent on imports that is not matched by a dollar of exports reduces domestic demand and employment. In a recent published report Professor Peter Morici of the University of Maryland (March 09, 2006) estimated that reducing the trade deficit in half would salvage employment and productivity enough to raise GDP by $300 billion or about $2000 for every working American. The upshot of job losses in trade competing industries due to persistent trade deficits are a reduction in investments in new methods, products, and skilled labour.

As we often say, there is no free lunch in economics and so is China's manipulative foreign currency reserve buildup is not without its risks either. A fixed exchange rate regime hamstrings China to conduct an independent monetary policy because the regime requires China to print yuan to purchase foreign-exchange inflows from trade and FDI. As a consequence, China's money supply has been growing at 15% - 18% annually, a rate that is overheating the economy and incubating the peril of inflation and ultimately another financial crisis may be lurking.

According to European Central Bank (ECB) estimates, world foreign exchange reserves grew to $4.0 trillion in Sept 2005 from 1.2 trillion in Jan 1995. Japan and China alone accounted for half of the build-up in reserves in the 2002-2004 periods and they now hold around 40% of world reserves. An ECB prediction on March 8, 2006 stated that further build-up of foreign exchange reserves in Asia could lead to problems such as inflation pressures, over investment, asset price bubbles, and complications in the conduct of monetary policy.

Foreign currency build up in emerging Asian economies is a threat if the monetary authorities become impotent in its ability to sterilize their intervention in foreign exchange markets fully. A sterilized intervention is a purchase or sale of foreign exchange reserves (that leaves the central bank's liabilities unchanged) and issue bonds to wipe up the extra liquidity generated by the intervention. An unsterilized intervention affects exchange rate by changing domestic interest rate. The ECB report argues that China successfully sterilized the monetary expansion resulting from intervention in 2002 but was not as successful in doing so in 2003-2004 partly because of a surging inflation from 0.8% in 2002 to 3.9% in 2004.

The broad consensus of the Finance Ministers who met in Vienna (April 7 - 9) was that global growth is expected to remain at more than 4% in 2006 and that the growth in the Euro Zone (EZ) will tiptoe to 2% from a slothful 1.3% in 2005. The EZ Ministers are endorsing a strategy of gradual appreciation in China's yuan, slighting US calls for faster steps to boost the yuan. They contended that a faster appreciation of the yuan could trigger sudden U-turn of Asian capital flows into the US causing a sliding of the dollar against the euro (to the detriment of the EU economies).

The EZ ministers, however, did not discount the risks to global economic growth stemming from higher oil prices, alarming US trade deficits ($854 billion) and budget deficits (over $9 trillion) and corresponding trade surpluses in Asia. If the EU and the US economy slow down, the demand for subsidized cheap imports from China and other Asian countries will also slow down potentially setting the inertia of a global recession in motion.

During my visit to Bangladesh in January, some of my friends in the business community wanted to know why the Bangladesh taka has been steadily declining against the dollar. My answer was that when everything else (such as corruption, governance, rule of law, political instability and everything else that could go wrong went wrong including the country's image) could worsen under Khaleda Zia's leadership, why the country's currency would move in the opposite direction.

Since 2001, Indian rupee has been gaining against the dollar (example: Indian rupee per US dollar: 44.101 (2005), 45.317 (2004), 46.583 (2003), 48.61 (2002), 47.186 (2001), whereas Bangladesh taka has been weakening (taka per US dollar: 64.328 (2005), 59.513 (2004), 58.15 (2003), 57.888 (2002), 55.807 (2001). In addition to the country's leadership image, other factors contributing to the weakening of taka include persistent current account deficits, budget deficits, and worsening law and order situations, and, of course, the rise of fundamentalist-led terrorism.

-- By far the most important factors are unbridled corruption and unrelenting political confrontations, and rise of religious fanaticism, which discouraged inflows of FDI and posed uncertainties in both export driven productions and unhindered supplies.

-- With dollar steadily hiking in value since 2001, Bangladesh with its limited exports (Example: finished garments, jute and finished jute products, frozen shrimp, leather products, pharmaceuticals, ceramic products which account for nearly 90% of exports) have had little or no scope for earning foreign exchange to match country's imports of capital goods, energy products, and luxury goods including automobiles for MPs.

-- Some of our limited exports (finished garments) are competing against other Asian countries whose currencies are artificially undervalued to nearly 40%.

-- The country's current account deficits with India, China and other trading partners coupled with low foreign currency reserves (which is primarily dependent on remittances from expatriates) may also be contributing to a continued weakening of confidence in the value of the taka.

-- Some insiders tell me that because of uncertain political milieu some dodgy importers and exporters may be over-invoicing imports and under-invoicing exports, thus transferring foreign exchange out of the country (alleged $230 million money laundering scam by the PM's son is one such example).

-- Bangladeshi politicians, specially the Jamaat-alliance government have the lowest image both at home and abroad compared to any democratic country in the world. Because of this image, quality of exports does not offer much confidence in the eyes of the western consumers. Unless that image is changed the country will have a rough ride ahead.

International trade facilitates firms to reap the benefits of economies of scale by operating in larger markets like the EU and the US with nearly 750 million combined consumers with hefty purchasing power. Currency manipulated export subsidy combined with low cost labour helped Chinese export manufacturers attain the economies of scale, record export growth and hence an unprecedented foreign exchange reserves. The world expects China open its markets to foreign competitors with the same market access that Chinese exporters harvest abroad, and adopt a market determined exchange rate regime by abandoning the current exploitative currency manipulation to gain mercantilist export advantage.

[I would like to thank my colleagues Professors Michael Vogt and David Crary and my friend Ghulam Rahman for their comments. The usual caveat applies for errors and omissions.]

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