A number of people and groups (President Obama, then members of Congress, and now the World Bank) have pressured the People’s Bank to let the exchange rate move relative to the dollar, some more angry than others. If they had any knowledge of Chinese culture and history, they would realize that these calls are counterproductive.
The bankers in China realize that the exchange rate needs to change by the end of this year. However, they continue to assert that they will keep the Yuan-to-Dollar rate stable for four reasons, some more public than others:
- They want to keep away speculators. If they gave any signal that their exchange-rate policy were to change, immediately a lot of hot money will begin flowing in, pushing the exchange rate further, and causing the central bank to lose some control over the exchange rate. By signaling that they’re keeping the exchange rate fixed (and by reaffirming that statement in the face of strong opposition to make it believable), foreign investors have less incentives to flood the Chinese market. Here, they have a conundrum–a weak and gradual revaluation will invite speculators, and an one-time revaluation will strongly hit domestic producers (especially those that export), giving them no time to adjust.
- They are running huge deficits with manufacturing countries like Germany and Japan. This is a sign that it’s the US’s fault for not producing goods or services that China demands, as opposed to Germany and Japan. The US simply does not export goods or services that appeal to Chinese businesses and consumers, and it isn’t up to China to remedy that.
- They don’t want their dollar-denominated assets to depreciate (too fast). They have the largest foreign currency reserves, a large portion in dollar assets like Treasury bills. If they let the dollar depreciate against the Yuan, they will have to take the world’s biggest capital loss. In fact, due to the Yuan’s 18% appreciation from 2006-8, at redemption value (in Yuan), their two-trillion-dollar investments in the US have lost 18% of their value (~400b dollars, or 3T Yuan). They don’t like how the US Treasury invited them to buy the US bonds, then turned around and instructed them to revalue their currency.
- But as a matter of policy (with the goal of stabilizing the economy), the exchange rate will have to change. Yet, the push by western legislators will be anything but productive. China doesn’t like reacting to foreign demands; it makes it look weak, appeasing, and reminds it of its history of submission to western powers in the past two centuries (Recall the Opium wars–Buy our opium! You wont? OK, we’ll beat you to submission). China has iterated many times: “We will not bow our heads to foreign powers.” It will not act in a way to give that impression. Reacting now to foreign pressure to revalue the currency will be exactly that sort. The most productive pressure will thus be private meetings wherein economics experts convince China that a stronger currency will be good for them in the long run.
China has let its currency appreciate in the past–starting the summer of 2006–as a part of its economic policy. The goal was to stifle the growth of asset bubbles and inflation. However, when the inflationary pressure disappeared in the summer of 2008, they stopped the appreciation. Instead, they turned to fiscal policy (a package whose total is a whopping 15% of their GDP) to support the world economy.
Now that the global financial crisis is over, and inflation is rising again, China will let its currency rise this year, but not as a result of foreign pressure. The best action for China is to assure President Obama privately that the Yuan will start appreciating before summer, at 5% a year for at least four years, but not because of foreign pressure. In the mean time, China should slowly unwind its positions in dollar assets before they depreciate any further–enough to get out of major positions, but not quickly enough to startle the markets.
In the long run, an appreciation of 20% in the Yuan-to-Dollar exchange rate will have negligible effects on the Yuan with respect to other currencies. China will move up the terms-of-trade scale, and other currencies (Japanese Yen and the Euro) will continue to be strong because of Japan and Germany. The Dollar’s decline is only a sign of America’s loss of competitiveness.
The currency problem is not one where the People’s Bank has good options. Either way, it will lead to a massive capital loss; and it will have to balance employment and inflation (and pissing off trading partners), yet ward off speculators. Hopefully western legislators’ lack of understanding of China does not lead to a trade war–that would benefit nobody.