May 13, 2005
By Jephraim P Gundzik
Asia Times
CALIFORNIA - Pressure from the Bush administration and the US Congress on Beijing to float the exchange rate of the yuan is increasing. But there is no economic justification for changing China's fixed-exchange rate regime. Rather than yuan revaluation, US demands for exchange rate adjustment in China should be seen for what they are: Washington's explicit support for dollar devaluation.
Over the past two years, Washington has increased pressure on Beijing to abandon the fixed-exchange rate of the yuan against the dollar. Treasury Secretary John Snow has used every occasion to harangue Beijing over floating the yuan. President Bush voiced his support for an interim step toward a yuan float on several occasions in early 2005.
The US Senate has joined the Bush administration in applying pressure on Beijing for an exchange rate adjustment. In April 2005, the Senate voted 67-33 in favor of considering legislation threatening Beijing with a 27.5% tariff on all US imports from China unless the yuan is allowed to float. According to senators Charles Schumer and Lindsey Graham, authors of the senate China tariff legislation, the Bush administration has quietly supported their efforts. A second Senate vote on this legislation is due by July 27.
This month, the US Treasury is expected to release its bi-annual report to Congress on foreign trade and currency manipulation. This report, mandated by the 1988 Trade Act, requires the Treasury to identify countries that are purposefully manipulating their exchange rates in order to gain a competitive advantage. The currency manipulator tag triggers bilateral negotiations intended to end the practice of currency manipulation in the offending country.
China was last named a currency manipulator by the US Treasury in 1994 in response to Beijing's devaluation of the yuan in that year. Since the 1994 devaluation, the yuan has traded in a narrow band against the dollar. Bilateral talks have failed to produce any changes in China's currency regime in the past 11 years. Nonetheless, it is probable that the new Treasury report will again brand China a currency manipulator given the consensus between the Bush administration and Congress that China must change its exchange rate regime.
Flimsy justification
According to officials in the Bush administration and in the US Congress, the intensification of pressure on China is primarily a response to complaints by US manufacturers. These manufacturers allege that China's exchange rate puts them at an unfair competitive disadvantage. Considering that wages in China are about one-tenth the level of wages in the US, a revaluation of the yuan by 25% - the eventual targeted exchange rate adjustment Washington seeks - would do little to improve the competitiveness of US manufacturers vis-a-vis manufacturers in China.
In addition, because China's exports have a large import component, the revaluation of the yuan would reduce input prices for China's exports, diminishing the impact of revaluation on export prices. Like the issue of competitiveness, the associated issue of China's growing trade surplus with the US is irrelevant to the exchange rate of the yuan.
Since the devaluation of the yuan in 1994, the average annual rate of growth of US exports to China has been 14%. Over the same period, the average annual rate of growth of US imports from China has been 18%. The long-term comparability in US-China export and import growth rates strongly suggests that China's exchange rate is neither under- nor over-valued relative to the dollar. Rather, the large and growing US trade deficit with China reflects the different nature of the two countries' economies.
Consumption versus investment
The consumption- and profit-driven US economy naturally seeks the cheapest source for consumer goods. Thanks to heavy US investment over the past 15 years, China is the cheapest source for these consumer goods. Rather than consumption-based, China's economy is driven by investment and export production. As a result, China does not have outsized demand for consumer goods.
In 2004, private consumption accounted for 70% of expenditure-based GDP in the US and only 43% of expenditure-based GDP in China. The difference in consumption patterns between the US and China is mirrored in the difference in savings rates in the two countries. The personal savings rate in the US is about 1% of disposable income. In China, the personal savings rate exceeds 40% of disposable income.
Unless the Chinese suddenly drop their strong bias toward savings, a consumption boom in China is extremely unlikely. Along the same vein, unless private consumption collapses in the US and Wal-Mart goes bankrupt, reversal of the US trade deficit with China will not materialize regardless of a 25% revaluation of the yuan against the dollar. Rather than focusing on the spurious issues of competitiveness and deficits, Washington should ponder the impact of a dollar devaluation on inflation in the US.
Dollar devaluation, not yuan revaluation
Though referred to by the Bush administration as yuan revaluation, what Washington is begging Beijing for is dollar devaluation. Like the 1985 Plaza Accord, Washington is again asking one of its largest trade partners to allow the dollar to depreciate. However, instead of Japan, as was the case in 1985, the US is pushing China to allow the dollar to depreciate against the yuan. The Plaza Accord led to the eventual devaluation of the dollar by about 50% against other major currencies. There is strong reason to believe that what begins as dollar depreciation against the yuan will eventually become another Plaza-style dollar devaluation.
China's foreign exchange reserves, the second-largest in the world after Japan, are expected to reach nearly $750 billion by the end of 2005. These reserves are overwhelmingly invested in US treasury notes. Presumably, Beijing would be loath to take a large capital loss on its investment in these notes in the event of an exchange rate adjustment in China.
Because an exchange-rate adjustment would result from a policy change in Beijing, it is likely that any adjustment would be preceded by the rebalancing of China's foreign exchange reserves, and related investments, out of the US dollar into other currencies. This rebalancing could trigger the devaluation of the dollar against the euro and the yen, currencies which the People's Bank of China would be selling its dollar reserves for.
The rebalancing of reserves by the People's Bank of China could inspire similar reserve rebalancing among other central banks in Asia and the rest of the world, all of which have substantial holdings of US dollars and US treasury notes. By begging Beijing for a dollar devaluation, Washington is inadvertently laying the groundwork for a much larger devaluation of the dollar, higher inflation, higher interest rates, and slower economic growth in the US.
Jephraim P. Gundzik is President of Condor Advisers, Inc, which provides emerging markets investment risk analysis to individuals and institutions globally. Please visit Condor Advisers for further information.
http://www.atimes.com/atimes/China/GE13Ad02.html