International | May 10 2006
By Chris Shaw (Tokyo)
Last year a proposal was put to the US Senate to label China as a currency manipulator for its policy of maintaining an artificially low value for the renminbi. A decision on this proposal is due in the next few weeks as part of the bi-yearly US Treasury report on currencies, though there is now speculation any decision will be delayed a few months.
Using the upcoming report as a backdrop, RGE Monitor has written a report discussing the implications of any move by the US to attach a manipulator label to China, as well as what can be expected in terms of China’s exchange rate policies going forward.
RGE points out under the criteria the Treasury has to determine if manipulation is occurring China scores quite highly, as it has large trade and current account surpluses, is accumulating foreign exchange reserves at a staggering rate and is acting to limit the currency from strengthening beyond the trading bands it has in place.
Additionally, given China has done little since late last year in terms of reforming its exchange rate mechanism the report suggests there is ample reason to apply the manipulator tag.
But RGE also notes there is a bigger issue at play, this being the political impact of laying such charges. For the US there is the possibility China would withdraw its support for other issues if it was accused of acting improperly in terms of its currency. There is also the fact the IMF is currently striving to achieve unilateral support for addressing imbalances in the global economy, which potentially could see China give ground on the exchange rate issue for the reward of greater recognition as an economic power in the international community.
The report suggests the potential impact of any decision against China is likely to be significant, as the US dollar would be likely to weaken further and US bond yields would rise. With many issues at stake, the report concludes the most likely outcome is for any decision to be delayed to give the Chinese additional time to show the Chinese authorities are serious about increasing the flexibility of the exchange rate.
Having said that, the report also points out the Chinese are likely to act according to their perceived economic needs rather than being influenced by pressure from the US. The concern for many in the Chinese government is a faster revaluation of the currency would result in a growth slowdown, which in turn could lead to social unrest particularly among the rural population.
The report identified two significant issues from the Chinese perspective, the first being it is becoming increasingly expensive to hold the currency at the current peg as the government is continually intervening in foreign exchange markets. This intervention creates the potential for another shock to the Chinese economy, as if a revaluation of the Chinese currency occurs the value of these foreign exchange reserves in local currency terms will also fall, potentially resulting in large losses.
The second issue is by holding to the peg the government is feeding the investment and credit boom, which is contributing to the imbalances in the Chinese economy. Chinese policymakers know the economy cannot continue at its current rate of growth if it is being driven only by exports and investment, as consumption and domestic demand must increase and savings decrease if the growth cycle is to be extended for the longer-term.
The report also points out by holding the currency down it makes the purchase of foreign assets more expensive, which is working against Chinese corporation being able to establish themselves on the global stage, another outcome that would have long-term benefits for the economy.
The report concludes the US is likely to hold off on branding China as a manipulator, as the pressures on the Chinese economy currently are sufficient to suggest the Chinese will move to adopt a faster rate of currency appreciation. Any such move is unlikely to be enough to put an end to the situation though, so a return of the issue to a more central stage is likely in coming months.
