Twists and Turns of Chinese Currency Management

The following news item from Reuters on Saturday (October 2nd) shows some remarkable cunning in an era when accusations are being hurled around about currency manipulation, and especially the Chinese version of it. This version, which is multi-faceted, and includes-- to the annoyance of the Japanese central bank-- the enthusiasm that the PBOC has for buying the yen whenever the BOJ tries to make it cheaper. The current visit by the Chinese Premier to Greece is now providing an opportunity for further magnanimity which could result in a stronger euro, which may not be exactly what Monsieur Trichet has in mind.

(Reuters) - China offered on Saturday to buy Greek government bonds when the country returns to markets, in a show of support for the country whose debt burden pushed the euro zone into crisis and required an international bailout.

Premier Wen Jiabao made the offer at the start of a two-day visit to Greece, his first stop on a tour of Europe, and also said he wanted to boost shipping and trade ties with Athens, underscoring Beijing's use of economic strength to win friends.

"With its foreign exchange reserve, China has already bought and is holding Greek bonds and will keep a positive stance in participating and buying bonds that Greece will issue," Wen said, speaking through an interpreter.

"China will undertake a great effort to support euro zone countries and Greece to overcome the crisis."

The last quote is particularly revealing as it achieves at least three objectives for the world's second largest economy:

1. It is a recognition by the Chinese authorities that in a fragile and totally inter-connected financial system, a serious crisis for the basket case EZ economies would be especially harmful to China, which has vast holdings of euros and the government bonds of the Eurozone constituent states.

2. The support of China for the sovereign credits of Greece, and quite likely the other PIIGS economies, will help to further bolster the euro against the yuan. This can only be good for Chinese exporters.

3. Furthermore it could have the effect of diverting attention away from the current antagonism between Washington and Beijing over the artificially low rate of exchange between the US currency and the yuan. Ironically by supporting the Eurozone financial system, and indirectly the euro, it will become harder for the ECB and the Federal Reserve to condemn the Chinese actions, which can only be considered as making a positive contribution from the perspective of helping to avert systemic anxieties.

In the post-2008 meltdown era, the trend towards a more altruistic form of "capitalism", some would even say outright socialization of the global financial system, China appears to be taking a leadership role in recognizing its dependency on the continued solvency of its less dynamic trading partners by rewarding them with pledges of further financial support. In so doing, the Chinese authorities will continue to find even more reasons to continue their policy of "currency management". Perversely, policy makers in the US and Eurozone may not appreciate such altruism.

Disclosure: No positions

About the author: Clive Corcoran

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Chinese 'Manipulate' Their Currency to Our Advantage

Politicians just can't leave well enough alone. Once again we hear the drumbeat of concern over the alleged fact that China has "manipulated" its currency—by keeping it too weak—and how that harms the U.S. economy. Yet nothing could be further from the truth.

To begin with, the Chinese yuan has appreciated by 23% since China's central bank first decided to peg the yuan to the dollar at the beginning of 1994—almost seventeen years ago. The Chinese economy has had plenty of time to adjust to its current currency regime, and if that weren't enough, the currency has appreciated significantly in the interim. Moreover, the Chinese have recently committed to allowing the yuan to appreciate even further, as suggested in the above chart.

Leaving aside the issue of whether they have kept the yuan artificially weak or not, China's monetary policy (which is driven by pegging its exchange rate) has been successful at delivering relatively low and stable inflation: since 1996, in fact, Chinese inflation has been substantially similar to that of the U.S (actually, it has been a bit lower—2% vs. 2.5% per year). This fact alone is almost proof that they haven't been keeping the currency artificially weak. (I'm leaving out 1994-95 since inflation in those years was temporarily boosted due to the 50% devaluation of the yuan that preceded its being pegged to the dollar.) In other words, our price level has risen about the same as the Chinese price level for the past 15 years. If the yuan had been chronically undervalued during that time, then Chinese inflation would most likely have been higher.

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Hearings Reveal Currency Bill Too Weak

On September 15, the House Ways and Means Committee held hearings about Chinese currency manipulations. The committee was remarkably united. One representative after another took shots at China’s trade manipulations.

They were almost all agreed that something had to be done, that President Obama’s policy was failing, that Secretary Geithner was not helping, and that China was not playing by the international rules. But they were not united about Rep. Tim Ryan’s bipartisan Currency Exchange Rate Reform Act (HR 2378) designed to end the manipulations that put American goods at a competitive disadvantage in U.S. and world markets.

If China were to really stop manipulating its currency, it would have to balance trade, which would result in more American exports to China as well as fewer American imports from China. But the opposition to Ryan’s bill claimed that the bill would hurt American exporters.

For example, Rep. Dave Camp (Republican from Michigan) perceptively pointed out that China is increasingly turning to socialism as a way to keep out American products. He said: “We cannot lose sight of more fundamental problems with China's economy that affect our trade balance, including the increasingly blatant and disturbing increase in the economic dominance of state-owned enterprises and the proliferation of non-tariff barriers preventing U.S. companies from exporting to China." In short, he didn’t see the bill doing anything to counteract China’s increasing barriers to American products.

Similarly, two state representatives from Kansas and Nebraska claimed that the bill could hurt American agricultural exports to China. Rep. Dave Reichert of Washington, a state with Boeing (BA) and many other big exporters, didn’t express an opinion, but he wanted to know, “What would be the effect on increasing US exports in China?”

Why is there any question about a bill designed to stop currency manipulations? After all, if Ryan's bill worked as designed, trade would balance. American exporters would gain, not just American companies that compete with imports.

Unfortunately, the Currency Exchange Rate Reform Act is not tough enough. Instead of a hard-striking across-the-board tariff on Chinese products, the bill provides for industry-by-industry countervailing tariffs to be phased in over time by the Commerce Department, giving China time to fight the tariffs with its own tit-for-tat tariffs accompanied by WTO suits.

The bill completely misses the innovation of our scaled tariff proposal, that the tariff rate be adjusted quarterly in order to take in as U.S. government revenue half of our trade deficit with China. China would want to import Boeing (BA) aircraft and Kansas wheat, in order to lower our tariff rate on their computers and windmills.

Ryan's bill is well-intentioned, but it is too tepid. The same is true of Senator Schumer’s bipartisan Currency Exchange Rate Oversight Reform Bill (S. 3134). The time has come for a strong enough bill to balance trade, not just help those American companies that complete with imports.

With just the few significant changes that we noted in our written testimony to the committee, Ryan's bill or Schumer's bill could take the profit out of currency manipulation, help balance the federal budget, reduce American imports, increase American exports, and resume America’s economic growth.

Disclosure: I own Chinese yuan through CYB

About the author: Howard Richman

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Why Asian Currency Interventions Will Create Sub-Optimal Economic Growth

Yesterday in The Economist, there was an interesting article arguing in favor of currency interventions: Monetary Policy: Beggar, then Sneakily Enrich, Thy Neighbor.

The basic thrust of the author’s position is that Asian currency interventions will create inflationary pressures, which would allow world economies to slowly escape recession. Currency interventions are also favorably compared to eliminating the gold standard during the Great Depression.

Unfortunately, the author might be missing the underlying reason why the elimination of the gold standard allowed for economic recovery in the Depression. Instead, the currency interventions might be better compared to the disastrous Smoot-Hawley Tariff Act in the United States.

It wasn’t merely that the elimination of the gold standard created inflation. The underlying issue was that the gold standard created arbitrary and inflexible monetary policy during the Depression. By doing this, it prevented market forces from operating and money supply was artificially suppressed. As money supply was distorted, the market was deterred from reaching an optimal growth result.

There were only two ways to fix the imbalance: (a) discover a large amount of new gold deposits and mine them or (b) eliminate the gold standard. As gold is a scarce good and world population was rapidly rising in the late 19th and early 20th Centuries, (a) was becoming an increasingly difficult proposition. For this reason, elimination of the gold standard was the only real solution. And it worked magnificently, as every economy that eliminated the gold standard was able to greatly ease the Depression. In fact, China, which was on the silver standard, was almost able to miss the Depression entirely.

The current situation has a lot of parallels, unfortunately. Mercantilistic currency interventions artificially constrain money supply, just like the gold standard did during the Depression. More importantly, the interventions fuel large trade imbalances.

It's not simply a matter of "creating inflation" in one nation --- the issue runs much deeper than that. By not allowing market forces to operate, some nations run massive current account surpluses (e.g. Japan, China) while others run massive current account deficits (e.g. US, UK, Spain).

Essentially, we're cheating the free market. It doesn't matter if an American or Spanish firm can more efficiently manufacture widgets than a Japanese or Chinese firm --- by intervening in the currency markets, it is arbitrarily dictated that the Japanese or Chinese firm wins out. However, the issue with this is that it produces inefficiencies. It might even be creating negative growth because more efficient firms are being pushed out of the market in favor of more inefficient firms.

On the other side of the equation, the currency interventions are actively harming Asian consumers. While these interventions can help create GDP growth, they do so at the expense of Asian wage-workers. Wealth is redistributed primarily to two groups: (a) American consumers and (b) the owners of capital of Chinese and/or Japanese exporters.

Or in other words, these currency interventions create over-consumption in the US and under-consumption in East Asia. Equilibrium is not allowed to occur and sub-optimal growth (or even economic contraction) results as economic efficiencies are destroyed.

Just to make things worse, the constant tug of war between market forces and the interventions creates greater economic instability that produces huge bubbles and busts. While Alan Greenspan and Congress should be given some credit for helping to create the housing bubble in the US, Chinese currency policy also deserves its share of the blame, as the constant currency interventions artificially lowered interest rates in America, helping provide more fuel to the housing boom.

It's worth noting that in spite of Chinese and Japanese currency interventions, both nations have eventually run into a brick wall where they have deprived their consumers of so much of their 'earnings', that they simply cannot afford it any more. This is happening in China right now, as Chinese workers are forced to demand greater compensation in order to deal with rising costs-of-living It also appeared to occur in Japan in the mid-80’s before the Plaza Accord, as Japanese economic growth had been waning after a nearly three-decade long boom.

For these reasons, the currency interventions might be more like the Smoot-Hawley Tariff than the elimination of the gold standard. Smoot-Hawley attempted to fix global trade imbalances by promoting trade barriers that created more imbalances. Inevitably, European nations retaliated against the United States and the tariff only exacerbated the crisis.

While currency interventions have a different economic effect, the end result is the same: economic efficiencies are deterred and sub-optimal growth becomes more likely. Until the international currency system is reformed and these mercantilistic trade wars in Asia are eliminated, we may continue to see a poor worldwide economic environment.

Disclosure: No positions in any currencies or national ETFs.

About the author: H.J. Huneycutt

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China Is Not a Currency Manipulator

… at least not according to the U.S. Treasury (see the Treasury’s Interim Report on Exchange Rate Policy).

According to the Treasury’s report:

China’s continued foreign reserve accumulation, the limited appreciation of China’s real effective exchange rate relative to rapid productivity growth in the traded goods sector, and the persistence of current account surpluses even during a period when China’s trading partners were in deep recession together suggest that the renminbi remains undervalued.

It was easy to overlook the recently released Treasury report in the wake of the G20 summit, where much of the debate centered on austerity versus stimulus rather than China’s mercantilist policies (see Agreeing to Disagree).

In this sense then, China’s strategy of publicly announcing a more flexible yuan policy in the days leading up to the G20 summit effectively deflected the debate away from the yuan. What’s more, China’s announcement was seemingly rewarded by a Treasury now more reticent to label it a currency manipulator. And the timing of the report’s release (after months of delay) seemed rather coincidental: It was released after the conclusion of the G20 meetings, and only after China seemed to mollify critics with its announced policy shift.

The interesting thing to me about the whole thing is that the yuan has barely budged since the announcement, rising less than 1% since late June. For a currency that some claim is undervalued by as much as 40%, that’s not likely to make much of a dent in persistent trade imbalances.

Now I’m as much a proponent of free trade as anyone (see Globalization Revisited and Globalization Discontents), but my view is that trade should be allowed to take place in an environment in which economies adjust as a consequence. Explicit policies that prevent such adjustment can be damaging to all parties.

With my bias now laid bare, it seems to me that China is simply paying lip service. It wants to appear accommodating, publicly declaring its intention to allow the yuan to strengthen against the dollar, while continuing to rely on exports to the US as its main growth engine.

Given the recent turmoil in Europe (China’s second largest trading partner), maintaining its exports to the U.S. has taken an even heightened importance (see Revaluation Postponed and Revaluation and Euro Weakness). And in a world where everyone suddenly wants to play beggar-thy-neighbor (China, Japan, and now even Europe), the U.S. is now everyone’s neighbor (for a brilliant treatment of the issues see Capital Tsunami).

This cannot continue indefinitely.

Against that backdrop, don’t be surprised if the trade deficit and cries of unfair trade practices begin to occupy a more prominent place in political discourse.

About the author: Robert Salomon

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China Is Not a Currency Manipulator

… at least not according to the U.S. Treasury (see the Treasury’s Interim Report on Exchange Rate Policy).

According to the Treasury’s report:

China’s continued foreign reserve accumulation, the limited appreciation of China’s real effective exchange rate relative to rapid productivity growth in the traded goods sector, and the persistence of current account surpluses even during a period when China’s trading partners were in deep recession together suggest that the renminbi remains undervalued.

It was easy to overlook the recently released Treasury report in the wake of the G20 summit, where much of the debate centered on austerity versus stimulus rather than China’s mercantilist policies (see Agreeing to Disagree).

In this sense then, China’s strategy of publicly announcing a more flexible yuan policy in the days leading up to the G20 summit effectively deflected the debate away from the yuan. What’s more, China’s announcement was seemingly rewarded by a Treasury now more reticent to label it a currency manipulator. And the timing of the report’s release (after months of delay) seemed rather coincidental: It was released after the conclusion of the G20 meetings, and only after China seemed to mollify critics with its announced policy shift.

The interesting thing to me about the whole thing is that the yuan has barely budged since the announcement, rising less than 1% since late June. For a currency that some claim is undervalued by as much as 40%, that’s not likely to make much of a dent in persistent trade imbalances.

Now I’m as much a proponent of free trade as anyone (see Globalization Revisited and Globalization Discontents), but my view is that trade should be allowed to take place in an environment in which economies adjust as a consequence. Explicit policies that prevent such adjustment can be damaging to all parties.

With my bias now laid bare, it seems to me that China is simply paying lip service. It wants to appear accommodating, publicly declaring its intention to allow the yuan to strengthen against the dollar, while continuing to rely on exports to the US as its main growth engine.

Given the recent turmoil in Europe (China’s second largest trading partner), maintaining its exports to the U.S. has taken an even heightened importance (see Revaluation Postponed and Revaluation and Euro Weakness). And in a world where everyone suddenly wants to play beggar-thy-neighbor (China, Japan, and now even Europe), the U.S. is now everyone’s neighbor (for a brilliant treatment of the issues see Capital Tsunami).

This cannot continue indefinitely.

Against that backdrop, don’t be surprised if the trade deficit and cries of unfair trade practices begin to occupy a more prominent place in political discourse.

About the author: Robert Salomon

View the Original article