JPRI Critique Vol. XII, No. 4 (August 2005)
Revaluation Reflects a Myriad of Competing Interests
by Marshall Auerback
To its apologists, China's recent decision to revalue could easily be explained as the first of many steps toward the beginnings of a significant currency regime change as well as signaling a willingness to accept the system responsibilities that come with being a leading member of the world economy. To its detractors, the move was purely cosmetic and will accomplish nothing in the short run.
It is hard to gauge the full implications of the move, especially since China's policy makers themselves seem so divided on the issue. Statements subsequent to the revaluation have been, to put it charitably, contradictory at best. After first suggesting that "the 2 percent adjustment of the renminbi is a first step that will be followed by further adjustment," the People's Bank of China later repudiated this statement.
By the same token, it is unclear whether the pro-revaluation constituency is as strong in America as implied by the laudatory remarks that followed China's action. The dirty little secret of both American and Chinese politics today is that the status quo (or at least something very close to it) tends to serve a number of powerful interests in both countries, even if pure economic logic suggests that a significant rebalancing between the "consumption bloc" of America and the "saving bloc" of Asia appears to be essential. Debating the revaluation issue within the limited parameters of "how much" vastly oversimplifies the issue and overlooks the important historic backdrop that explains China's current reticence to do more. A more accurate description of the issue might be that the debate over the renminbi reflects a myriad of competing interests among various transnational elites with divergent interests jockeying for position in the Rule the World Sweepstakes.
In the days following China's long-awaited (and somewhat anti-climactic) implementation of its revaluation, Zhou Xiaochuan, governor of the People's Bank of China, the central bank, indicated that the measure was only "an initial step." But this statement itself was subsequently repudiated by other figures within the central bank who insisted there would be no more government-led revaluation of the renminbi. The PBOC indicated again during the first week of August that in trading since revaluation, the renminbi had been reflecting market forces and movements in international currency exchange rates. "Some foreign people have tried to create misunderstanding by saying this adjustment is an initial move and there will be more to come," the bank said, adding that such foreigners were saying this "to suit their own purposes." In fact, the PBOC said, the renminbi rate was being set "according to objective rules," although what those "rules" are is anybody's guess, since the Bank has been conspicuously lacking in transparency when it comes to revealing the constituents of the currency's new basket.
It is always difficult to gauge the true intentions of China's leadership, but the conflicting statements appear to reflect an ongoing split among various factions. Although it is said that the PBOC's governor is himself an advocate of an even more dramatic revaluation, the ultimate result is said to vindicate the cautious, step by step approach of Wen Jiabao, China's premier.
And for all of the talk of how the move has temporarily blunted incipient protectionist pressures emanating from the U.S. Congress, it is also clear that other less vocal, but equally powerful constituencies in America will find this minimalist approach palatable, given the extent to which China's ongoing purchases of U.S. Treasuries have held down bond yields and so fuelled the housing bubble that has been the source of the country's ongoing economic "recovery."
As things stand today, the mere 2 percent revaluation introduced thus far is pretty much a non-event. According to Bridgewater Associates, sheer economic logic and history suggest further appreciation to come. The group recently provided a sophisticated exposition of the likely course of events for the yuan , based on the fundamentals and on the assumption that China is managed with the objective of maximizing economic utility.
They draw an analogy with the Japanese experience of 1968-78.
"We think that it is inevitable that the RMB will be about 25% to 30% higher in three years and about 60% higher in 10 years, because we believe that it is in China's interest to have this happen....Since we think that it is inevitable that real incomes in China will continue to rise relative to those in the U.S. at a fast pace and that it's in China's interest to run monetary policy to balance growth and inflation, we believe that it is in China's interest to have its real exchange rate appreciate at a fast pace and to have an independent monetary policy.
"...We believe that the relevant analog is Japan in 1968-78 when the circumstances were similar -- i.e., (a) real per capita incomes in Japan were very low relative to the U.S. (60%), (b) the trade balance/current account, growth rate and investment/saving rates gaps were huge, and (c) the Japanese were trying to hold the exchange rate the same via huge bond purchases. Note that in Japan's case, reserves increased by about 3-4% of GDP... .In China's case, the increase was more than 20% of GDP."
In many respects, the Bridgewater analysis appears sound. Logic suggests that a country of China's scale cannot continue to drive trade ratios ever upwards. It is also true that there is virtually no case of even one improperly pegged exchange rate being re-pegged at another improper level and staying there. Already China's ratio of trade (exports plus imports) to GDP is 70 per cent. This is much the same as for South Korea. As Martin Wolf of the Financial Times observed recently, a country with a population of 1.3bn cannot grow at 10 per cent a year and remain as dependent on trade as one with just 50m without provoking a backlash from its trading partners, which is clearly occurring today. On current trends, China will likely generate well over a sixth of the overall current account surplus of emerging market economies (including the oil exporters) in 2005. It also has an extremely strong capital account position.
On the other hand, given recent history, China's reticence to do more is understandable. During the 1997/98 Asian financial crisis, the triumphalist rhetoric of American leaders basking in their economy's "stellar performance" alarmed and deeply antagonised Asia, including the Chinese. Instead of offering a helping hand to countries long viewed as steadfast Cold War allies, the U.S. Treasury very visibly exploited the crisis by seeking to destroy Asia's model of "alliance capitalism." Critics such as former Treasury Secretaries Rubin and Summers, and Fed Chairman Alan Greenspan, virtually ignored the region's real sector economic variables -- its sky high national savings, rapidly rising educational levels, low inflation, high productivity, balanced fiscal policies. Instead, these figures publicly denigrated Asia's substantial achievements, focusing almost exclusively on the region's financial instability, and its alleged "crony capitalism."
In the end, it was collapses in domestic demand, coupled with vastly undervalued exchange rates, which generated massive current account surpluses for the region, sometimes equal to 10% of GDP, that in turn re-established official forex reserves and stabilized the region's external financing. Having bounced back with their savings largely intact, reserves growing substantially, and a degree of policy-making autonomy restored, these countries understandably began to associate current account surpluses with national autonomy.
China by and large avoided the worst of the contagion effect. Its 8 percent GDP growth sustained during 1998 was all the more remarkable given the exogenous shocks to growth in the region and the concomitant slowdown in world trade. The comparative resilience of China's economic performance came about largely because Beijing's policy makers eschewed the Hooverite policies of the IMF. Instead, they retained control of the capital account, moved very aggressively to reflate and thereby helped lead the region out of its deep recession. China held the line on its renminbi exchange rate to avoid another round of currency depreciation in the region, ironically lauded at the time by the very same U.S. Treasury which today calls this identical policy "currency manipulation."
Proponents within China of a more gradualist revaluation policy argue that it is not China that is the source of today's massive global economic imbalances. Rather, the persistent refusal of the American government to conduct economic policy with an eye toward preventing a loss of U.S. competitiveness and a corresponding rise in huge external imbalances has caused the relative shift in economic fortunes in regard to America and Asia. Given that America's policy makers show no inclination to curb the country's extraordinary profligacy, leaders in China have understandably wondered why their country alone should bear the burden of adjustment by substantially revaluing their currency.
By extension, they contend that those who bay for a further substantial revaluation should be careful what they wish for. Such a measure would almost surely push bond yields higher and badly hurt America's economy. Indeed, if the yuan's adjustment has any real impact on America's trade deficit, it will not be through the revaluation itself, but because higher bond yields squeeze domestic demand.
To that extent, as The Economist has recently noted, " Global monetary policy is now made in Beijing, not Washington." America's loss of monetary control parallels the ongoing depredations in America's manufacturing sector. Indeed, with its seemingly perpetual championing of financial interests over manufacturing interests over the past fifteen years, the U.S. appears to be placing itself in a position as vulnerable as Asia was in 1998. Wall Street and Congress have tolerated the Chinese undervaluation strategy since the1990s, which has basically been a disaster for Middle America, notably the now almost extinct manufacturing sector, and a bonanza for the purveyors of finance capitalism.
The finance capitalists have now found their interests enmeshed with those of the defense establishment. Given America's ongoing war on terror, continued foreign funding has increasingly become a necessity. Without the purchase of U.S. debt by China and the Asian countries it drags in its wake, the burden of conquest would have to be placed directly on the U.S. taxpayer, who might well object.
For China's leadership, this provides an added fillip for a country that as recently as 2001 was classified by the Bush administration as a "strategic competitor." When China's fixed exchange rate was being sustained during the Clinton years, Beijing's monetary officials had a clear economic incentive to minimize the contagion effects of the enveloping Asian financial crisis. Since then, the U.S. has suffered terrorist attack and become mired in an intractable insurgency in Iraq. Now Beijing's policy makers are helping their main geopolitical rival enmesh itself in conflict with the Muslim world, which has the added bonus of keeping the Pentagon's hawks away from stirring up excessive trouble in the Taiwan Strait. To add to the never-never land quality of this situation, the Pentagon is encouraging prime contractors to outsource components and systems from Asia to reduce costs. This sort of decision may make sense as a profit-maximising exercise for a restricted group or groups, but it makes no sense whatsoever from a national security or national economic point of view. Within this broader context examining the size of a revaluation appears akin to reorganising the deck chairs on the Titanic.
Marshall Auerback is a Denver-based international financial analyst who writes regularly for JPRI on economic and political developments in East Asia. His most recent article was "Last Orders for the U.S. Dollar?" JPRI Critique XII:2 (March 2005).