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Saturday, June 26, 2010

Appreciating the renminbi


Special to The Japan Times

HONG KONG — Global stock and foreign exchange markets were fast out of the blocks to lead the applause for China's decision to free the exchange rate of the renminbi. Clearly licking their lips at the prospect of greater foreign access to China's fabled market of 1.3 billion consumers, stock markets in Japan and Asia leaped by 2.5 to 3 percent, Europe and the United States followed, while the 12-month forward rate of China's currency against the dollar was at 6.62, implying a 3 percent appreciation. (This compares with 25 percent by which advocates of renminbi appreciation believe the currency is undervalued.)

Yet the real lessons of Beijing's surprise move are that markets are not to be trusted in understanding complex politics and economics, and that China is still not prepared to be a responsible player in the global economy.

The markets had the excuse that U.S. President Barack Obama, his treasury secretary and the European Commission all praised Beijing's decision as opening the door to a new flexible and more open regime, even though China clearly warned that, "There is at present no basis for major fluctuation or change in the renminbi exchange rate."

It is hard not to be cynical about the political posturing on all sides, and worried about blinkered leaders who see global economic issues through a narrow nationalistic lens. China indeed laid down a pre-emptive battery just before this weekend's Group of 20 summit in Toronto, warning the rest of the world sternly that it had no right to discuss China's currency. The subsequent decision to float the renminbi again was a sop to the U.S. and others, but it is also in China's interests as leading officials of the People's Bank understand.

The interesting question is whether Obama and Geithner were hook-winked in applauding China's new found flexibility or whether they were playing along in a game to head off rising U.S. criticism of China's exchange rate policy. In the last few weeks big U.S. corporations, backed by some influential senators threatening legal sanctions, have resumed their angry contention that China's undervalued currency is penalizing their exports.

Beijing claims its exchange rate is an issue of sovereignty for it alone. But since exchange rates set the price at which countries export and import goods to and from other countries, exchange rates are by definition an international trading issue.

The Group of Seven, the G20's effective predecessor body of the global economic powers, spent endless hours discussing foreign exchange rates with, at various times, the so-called strong dollar and the alleged damaging weakness of the yen on the front line. Reporters scanned not only the words, but also the placing of commas in communiques for clues as to whether the G7 would initiate action to push forex markets. The lesson of the G7 is that China does not need to worry since even the smaller more homogenous G7 could rarely get their act together to agree to currency intervention.

What chance is there that the much more assorted membership of the G20 — without the backing of a history or a secretariat — will be able to agree on a common position on contentious currency rates?

The real tragedy of the endless argument about China's currency is that it is being abused to make political points rather than for a serious economic discussion. Even if and when China does permit a float it will be carefully managed to prevent speculators from deploying their trillions of dollars in a bet on the currency. Beijing is right to claim that it is impossible to plan for an economy if the currency is 6.83 against the dollar today, 6 tomorrow, maybe 5.5 the next day and 5.8 the day after that as traders play their games. Japan has enough experience of the damage of currency fluctuations.

Americans are also wrong to expect that an appreciating renminbi would allow them to grab a big chunk of the China market that they have been missing so far. Big U.S. companies like Wal-Mart and General Motors are already in China and taking advantage of low labor costs and the stable renminbi. Foreign-invested enterprises account for more than 50 percent of its exports and 75 percent of its trade surplus. Exporters from places like Brazil, India and Vietnam would probably prove more competitive if China's currency appreciated.

Cynics like Yves Smith of Naked Capitalism say that if China changed its basket of currencies to give greater weight to the euro and then allowed the renminbi to float, it might actually be devalued — not revalued — against the greenback to account for the appreciation against the euro that has already taken place. The European Union is China's biggest trading partner.

Nevertheless, China's trade surplus is a huge problem, for China and its people as much as for the rest of the world. As professor Michael Pettis of Peking University pointed out, China's trade surpluses, amounting to 0.6 to 0.7 percent of global GDP, are the highest in more than 100 years, bigger than those of the U.S. in the 1920s, at 0.4 percent of global GDP or Japan in the late 1980s (0.5 percent). Yet China, accounting for only 8 percent of global output, is a much smaller economy than either the U.S., with 30 percent of global GDP in its 1920s heydays, or Japan, 15 percent in the 1980s, when it was a big exporter.

It would make economic sense for China to revalue, as the International Monetary Fund, the World Bank and countless think tanks have urged. An appreciating currency would help to cool inflation, already 3.1 percent in May or higher than the government's full year 3 percent target, would make imports cheaper and might give China's consumers a chance to enjoy the economic boom that as workers they have toiled hard for.

The reluctance is political, particularly China's politics of exporting. There are signs that the People's Bank would like to see the currency appreciate, but it has to play second fiddle to the powerful commerce ministry, the protector of politically well-connected exporters, some of whom operate on wafer thin margins, which would not be acceptable anywhere else in the world.

It remains to be seen how long it will take for China's leaders to understand that a low-wage, low-value renminbi economy with massive exports and mounting foreign exchange reserves held in vulnerable dollars and euros is not a fruitful or sustainable way for a developing economy.

Perhaps recent labor unrest, carefully tolerated at foreign-owned factories, will make the point that China has to go upmarket with higher wages, greater productivity, higher value production and a developing service sector. The hope might be that the People's Bank was trying to make the point to its own country in its tortuous promises of renminbi flexibility.

Kevin Rafferty is editor in chief of PlainWords Media, a consortium of journalists interested in economic development.


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