We recently hear a lot about the need for China to adjust the exchange rate of its currency, the yuan. In fact, Federal Reserve Board chairman Alan Greenspan, during the U.S. Senate Banking Committee hearing July 16, said it is “increasingly evident” that China should allow its currency to trade freely on the market.
Asian currency adjustments were also discussed at a conference in Bali earlier this month among finance ministers from the Asia-Europe Meeting (ASEM) member nations, where Finance Minister Masajuro Shiokawa of Japan noted yuan’s appreciation would benefit China in the long term.
Behind these arguments is, of course, the rapid increases in China’s exports and foreign currency reserves, which stood at $324.9 billion at the end of March. Another factor is that — since the yuan is effectively pegged to the U.S. dollar — a decline in the buck will automatically lead to depreciation of the yuan.
However, the United States, Europe, Japan and other Asian countries all differ in their seriousness about pushing for a rise in the value of the yuan. Also, we need to realize that despite its obligations under Article 8 of the International Monetary Fund charter, China has continued to suspend external convertibility of the yuan. In other words, China is banning the use of its own currency in import and export transactions. This is why Japanese banks do not quote yuan exchange rates.
The strongest advocates of yuan-adjustment have been the Europeans. Many Asian countries, including China, kept their currencies effectively pegged to the dollar even after the 1997 Asian financial crisis. When the dollar fell to as low as $1.2 against the euro, the Asian currencies also fell against the euro, triggering discontent that European exports were being hurt. Those arguments, however, have abated somewhat amid the euro’s recent weakness.
Meanwhile, the United States doesn’t appear to be pushing so strongly for yuan appreciation, even though China accounts for the largest portion of its trade deficit. This is because the savings shortage in the United States — or its external deficit — is being covered by the hefty amounts of foreign currency that Japan, China and other Asian countries are pumping back into the U.S. Last year, China accounted for 23.7 percent of the U.S. trade deficit, followed by the euro-zone countries with 18.9 percent, Japan with 16.1 percent, Canada with 11.4 percent, Malaysia with 3.1 percent, South Korea with 3 percent, Thailand with 2.3 percent and India with 1.8 percent. It is evident such deficits are unsustainable, and the U.S. may toughen its position toward China as the 2004 presidential election approaches.
What has been the reaction of the rest of Asia? It is worth noting that China’s share of the U.S. trade deficit is already larger than the 11.6 percent accounted for by the other Asian economies (excluding Japan) combined. These economies are now concerned that China, with its cheap labor and real estate, is gobbling up the lion’s share of investment from the industrialized countries. Their sentiment toward China is also compounded by the view that one of the factors that triggered the 1997 financial crisis was the depreciation that occurred when China dropped the distinction between yuan for domestic circulation and yuan convertible to foreign currencies.
Behind Shiokawa’s remarks at Bali were expectations from bruised and battered sectors of corporate Japan that yuan appreciation will save them. But Japan must not forget that it has a huge current account surplus. What is happening between Japan and China today is just a replay of what happened between Japan and the U.S. after World War II. In other words, Japan is now being required to shift its industries to higher added-value sectors.
Then what should China do? China suspended yuan convertibility as a temporary measure to fend off pressure for a devaluation during the Asian crisis in 1997 and hasn’t lifted it since. With its entry into the World Trade Organization, however, China needs to open up its economy in accordance with the agreed-upon timetables. At the same time, productivity at state-run corporations and the farming sector remains low. Given that the number of Chinese people effectively without jobs exceeds Japan’s total population, China obviously cannot afford to pursue liberalization and currency appreciation simultaneously.
China should start by fulfilling its obligations in accordance with its status in the IMF and restore convertibility to the yuan for its current account.
Then it should gradually liberalize its capital account. By studying Japan’s experience in the 1960s, when it liberalized the economy sector by sector while trying not to hurt the international competitiveness of its industries, China may learn an invaluable lesson.
The pressure to liberalize Japan’s economy began to intensify around 1964, when the nation hosted the Olympic Games in Tokyo. I don’t think China right now can afford to raise the value of the yuan. It is also true that China, with a population 10 times larger than Japan’s, faces mounting problems, such as regional gaps in economic development and growing democratization movements. But as China prepares to host the Olympic Games in Beijing in 2008, it will inevitably face increasing pressure to liberalize.