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High price for cheap yuan

by Kevin Rafferty

HONG KONG — U.S. President Barack Obama decided to back off at least from an immediate direct confrontation with China over the value of the yuan. It is a sensible decision on both economic and political counts. But there is no sign yet that policymakers and noisy troublemakers in Washington, Boston, New York, Tokyo and — least of all — Beijing understand that much more needs to be done: some radical thinking, new attitudes to bilateral and multilateral relations, or we all face a grim future in which a trade war would only be the first dangerous escalation.

What has been done is to buy some time, but time must be used wisely, not wasted.

Chinese President Hu Jintao and Obama obviously did a deal whereby Washington postponed a decision on whether to name China as a “currency manipulator” to tempt Hu to attend the Washington nuclear security summit and support the United States over its concerns about Iran. The links between the nuclear summit and the currency question offer a reminder that these are just two strands in a huge spaghetti plate of vital issues today tying Washington to Beijing and Tokyo and other global capitals.

If the rumors are correct, Beijing is preparing for a small revaluation of the yuan, starting with a widening of the trading band, leading to a revaluation of 5 percent or so. But that is only a baby step forward, and needs to be followed by other action. Without further measures, hawks in the U.S. will still be demanding more, and China will get angry saying that it listened to Washington’s pleas and instituted a revaluation, and ask what more the U.S. will demand of it.

There is no single unified voice coming from the American side. Some economists and bankers, particularly those in daily business contact with China, say there is no point in making Beijing angry by name calling or applying insulting labels.

Nobel laureate Joseph Stigltz has given economic respectability to those urging caution, warning of dangers of a trade war and pointing out that the root of America’s economic problem is the imbalance between savings and investment, not the trade deficit with China. He predicted that even a 10 percent revaluation in the yuan would not have a significant effect on the U.S. trade deficit and would not cause companies to dismantle their factories in China to return to the U.S.

But Stiglitz does not give due weight to the political head of steam against China, which has its own Nobel economics laureate, Paul Krugman — a trade expert — in the vanguard claiming that China has been deaf to all pleas to adjust the currency for so long that it is time to bring out the big stick to show that Washington means business.

Those demanding action from China — or forceful U.S. measures — offer economic research that points to a yuan undervaluation of not 5 or 10 percent but between 25 and 40 percent, the growing Chinese surpluses, foreign exchange reserves close to $3 trillion properly counted and massive Chinese interventions to keep the yuan pegged at 6.83 to the greenback. Such a huge undervaluation is effectively an unfair trade subsidy, says Fred Bergsten, director of the highly respected and influential Peterson Institute for International Economics.

A world away are the Chinese economists who speak with a single voice and take their cue from the ministry of commerce, resisting any revaluation. What is most worrying is the fierce nationalist edge to some of the Chinese comments, notably from academics abroad, some of whom seem to have forgotten the demands of honest scholarship.

Lanxin Xiang of the Graduate Institute of International and Development Studies in Geneva claimed last week that Obama “has been effective in forcing China to dance to the U.S. tune. . . . China’s (economic) dependence on the U.S. market has reached such an unhealthy level that its U.S. debt holdings are, in effect, being held hostage. . . . The ‘financial balance of terror’ has tilted in favor of the U.S. government. . . . The fact that Chinese are financing U.S. budget deficits has been obscured entirely.”

China and the U.S. are in a potentially dangerous symbiotic relationship, which needs statesmanlike thought and mutual action to re-balance economies, not short-term palliatives like a small one-off revaluation, and still less dangerous political feel-good measures like pinning “currency manipulator” labels on China.

Obama and his treasury secretary Geithner, if they have any sense, will sympathize with Hu and China, and do it publicly in the context of G20 meetings. A small, one-off revaluation will not work, and nor will throwing the value of the yuan to the mercy of currency speculators by making the currency flexible, as former treasury secretary Henry Paulson advocated. Is he looking for more profits for Goldman Sachs to play with the yuan as they played with other financial markets?

The U.S. should be grateful to China that Walmart, Nike and other brands have been able to set up factories in China to produce cheap consumer goods for America and other markets.

But there has been a big price to pay. The biggest losers have been ordinary Chinese whose hard labor has been turned into government holdings of U.S. treasuries and other foreign exchange reserves, which are at risk of losing value in a yuan revaluation. Beijing and Washington both need to acknowledge that the U.S. economy has been too dangerously driven by consumption — just as China’s economy lacks the driving force of domestic consumption.

Zhong Shan, China’s vice commerce minister, claimed this month that the profit margin on many Chinese export goods was “less than 2 percent.” If this is true it means that “Walmartization” — the ability of powerful retailers to squeeze profit margins — has got out of hand since normally double digit margins would be the order for exporters.

Other losers have been other countries that have suffered from China’s implicit export subsidies through the undervalued yuan, which means the U.S. to some extent, but other developing countries more so.

That is why it is important for the European Union, Japan and India to get involved and to help Obama and Hu soften the blows of a transition and put together a global package, which will see the U.S. raise its savings and investment — as it has started perforce to do — and China turn on the engine of domestic consumption. A revalued yuan — but one kept from the mercy of market speculators — is an essential part of this economic re-balancing.

Beijing is worried that a higher yuan would lead to the problems that Japan had in the 1980s and 1990s when the yen appreciated, but China is a still-developing economy with lots of room to grow, not the sluggish and mature economy that Japan was.

The essential problem, however, is that this is a global problem, not merely a bilateral one. It cannot be solved unless surplus countries make efforts to increase domestic demand and reduce surpluses, and deficit countries adjust their own domestic economies to match. But then we are back to the lack of presidents, prime ministers and finance ministers with a vision beyond their own backyard and the next election.

Kevin Rafferty is a veteran commentator on Asian politics.