Ever since the world lurched towards a new Great Depression
in September 2008, the value of the Chinese currency has been
the elephant in the room for global policy-makers.
China played a key role in the coordinated effort by
governments to stabilize the world economy, injecting $586
billion into the financial system. At the same time, however,
Beijing pegged its currency, the renminbi, to the US dollar at
a rate of Rmb6.83 per dollar after allowing it to appreciate
for three years.
As world leaders in the worst affected wealthy countries
strove to maintain unity in the face of the downturn, the issue
of exchange rates was quietly ignored. Now, with the global
economy on track for an admittedly weak recovery, calls for
currency appreciation have been increasing in both number and
While China sees the peg as part of a strategy for reviving
growth, rival economies condemn it as artificial undervaluation
designed to give its exporters a massive trade advantage. This
pressure came to a head in the US in March when 130 members of
Congress signed a letter calling on the Treasury to label China
a currency manipulator.
The Treasury was due to make an announcement on whether to
identify publicly any currency manipulators among major trading
partners on 15 April, but at the last moment decided to
postpone the decision.
As Simon Evenett, a professor at St Gallen University in
Switzerland and an expert on world trade, says: Thanks to
some deft diplomatic footwork, a confrontation between the US
and China over the latters exchange rate regime has been
avoided for the time being.
Those last four words are crucial. Financial markets are
speculating on when and by how much not if the
renminbi will be allowed to rise.
Wei Li, an economist at Standard Chartered Bank in Shanghai,
expects Beijing to allow the currency to rise by 2% in the
second or third quarter of the year. A strong rebound in
export growth and rising pressure from the US have renewed
market speculation of a possible near-term de-peg from the
dollar, he says.
Mark Williams, senior China economist at Capital Economics
and formerly at the UK Treasury, has pencilled in June as a
likely date for a revaluation that will see the yuan appreciate
3% this year and 6% in 2011, ending the year at Rmb6.20.
He says that by then, the data fog around the Chinese New
Year will have cleared. They want to be confident about
the economic situation, and by June they will have had a couple
of months of clear data.
Wei plays down speculation of a one-off revaluation of
35%, saying such a move raises too much risk for a
Whoever is right, moves of 2%, 3% or 6% are chicken feed
compared with what the most vociferous commentators are calling
for. The Nobel Laureate economist Paul Krugman, who publicly
backed the Congressional letter, called for a supplemental
tariff of 25% to be applied on Chinese imports.
Fred Bergsten, director of the Peterson Institute for
International Economics and a former US Treasury assistant
secretary, says the renminbi is undervalued by 25% on a
trade-weighted average basis and 40% against the dollar.
This competitive undervaluation of the Chinese
currency is a blatant form of protectionism, he says.
It subsidizes all Chinese exports by the amount of the
misalignment, between 25% and 40%.
According to Bergsten, this currency misalignment is
fuelling global imbalances at a time when policy-makers are
striving to get the economy on a path of sustainable, balanced
Chinas current surplus hit $297 billion last year
down from $400 billion at the peak of the boom in 2007
but still 6.1% of its GDP, according to the latest data
IMF chief economist Olivier Blanchard calculates that by
2014 Chinas surplus could account for 0.9% of world GDP
greater than the entire US deficit, which will reach
Mark Williams believes the Beijing authorities are aware of
the need to take action to prevent a fresh crisis in the world
economy. China does not want to see its relations with
the rest of the world poisoned, he says. People say
that China wont bend to foreigners pressure, but
thats largely nonsense.
Like any country, they will do whats in their
best interest, and if foreigners are threatening to bring a
trade war down on their heads, they will take action.
Indeed, just days after US Treasury secretary Tim Geithner
postponed the decision on currency manipulation, Ba Shusong, of
the Development Research Center, the cabinets think-tank,
said the peg was a temporary emergency measure that would be
abolished at some point.
When the elephant finally stirs, the issue for Chinas
trading partners in Asia as well as the West will
be how significant the tremors will be.
The first impact from a currency appreciation should in
theory be a fall in exports from China and a contraction in the
current account surplus something that will appease US
politicians and reassure the authorities at the IMF.
Meanwhile, the fall in the renminbi will cut the price of
imports, which will make households feel richer and encourage
them to spend, thus boosting domestic demand.
As Michael Pettis, finance professor at Peking University
and a former Wall Street trader, says, this is the key
point. A revaluation shifts wealth from the Chinese
government and the manufacturing sectors to Chinese households,
which is pretty much what is meant by rebalancing in the
Chinese context, he says.
Not only will China have a safer and more balanced
economy, but it will be more innovative, as consumption tends
to drive innovation not production, and much more
Whats unknown is how the rest of Asia will be
affected. On the one hand, it could be a blessing for
Chinas Asian neighbours. Some, such as Hong Kong,
Malaysia, Singapore and Taiwan, have all sought to keep their
currencies undervalued against the dollar. A Chinese
revaluation could give them an opportunity to bypass China and
compete as an alternative supplier to the West.
However, revaluation could equally be a curse. Alicia
Garcia-Herrero, chief emerging markets economist at BBVA in
Argentina, says small Asian states will suffer from being so
well integrated into Chinas supply chain. Exports
from other Asian countries seem to be more of a complementary
than a substitute to Chinese products, she says.
Roughly a fifth of their exports go to China. A 10%
appreciation in the renminbi would cut exports from many
south-east Asian countries by as much as 17% as demand for
components slowed, her research shows. A fall in
Chinas imports contains major consequences for the wider
region as it is mainly imports from other east Asian countries
which fall, says Garcia-Herrero, who is also a professor
at Hong Kong University.
But Mark Williams warns against reading too much into local
side effects of revaluation: Dont overdo it,
he says. I dont expect the pace of change to be
particularly great. The idea of 3% this year and 6% next year
compares with the usual currency movements and is not very
Indeed, over the last 12 months the Indonesian rupiah has
risen by 18% against the US dollar, while the Thai bhat is 10%
up and the Singapore dollar 8% higher.
Pettis believes an appreciation of the renminbi which
he sees as happening in the next month or so
would lead to a realignment of a number of other
Asian currencies that have run currency pegs. Several
other Asian economies are facing domestic monetary pressures
and so would like to see their own currencies appreciate, but
they are afraid to do so until after China commits to doing the
same, he says.
But he warns: Of course there will always be the
temptation to appreciate less than trade competitors so as to
gain market share. This is going to be a thorny
Of course, concerted currency appreciation among surplus
currencies is exactly what bodies such as the IMF are calling
for. Currencies of a number of emerging Asian economies
remain undervalued, substantially in the case of the
renminbi, the fund said in its April World Economic
Outlook. In emerging economies with excessive surpluses,
monetary tightening should be supported with nominal effective
exchange rate appreciation as excess demand pressures build to
facilitate demand rebalancing.
Ultimately this process should be part of a coordinated
strategy to deliver a rebalanced global economy, the lack of
which was a cause of the financial crisis.
Another reason why economists see June as a likely time for
Beijing to take the first step towards appreciation is the
timing of the G20 Summit in Canada. When Geithner
postponed the currency report, he specifically said over the
next three months that they would be pursuing other
avenues, says Mark Williams. That suggests that
China will be coming under pressure by the end of June when G20
leaders meet. If China leaves it much beyond that, then it will
be harder for them to act without being backed into a
Pettis believes the G20 can be the right forum for
successfully applying pressure on China to allow appreciation
of its currency. He points to public calls in April by
governors of the central banks of India and Brazil
fellow members alongside China of the key Bric (Brazil, Russia,
India and China) caucus for faster renminbi
The G20 may very well be the best forum for this
discussion, because it generalizes the debate and allows China
to claim that they are not reacting to rich-country
bullying, he says.
But it is not only Asian nations that need to take action.
Deficit-laden countries such as the US need to improve their
fiscal position, while surplus countries including
Germany, Japan and Opec (Organization of the Petroleum
Exporting Countries) nations need to boost domestic
demand. As Pettis points out: The global imbalances
consist not just of US overconsumption and Chinese
overproduction, but of imbalances in nearly every major
While it looks increasingly likely China will soon embark on
currency reform for the first time since June 2008, that is
unlikely to be the end of the story. While western countries
are already acting quickly for their own reasons
to cut deficits, action by surplus countries will take longer
to bear fruit. Whatever Beijing does, it will meet with
impatience in the US, Pettis notes.
The possibility of continued political anger within the US
and demand for tariff hikes that would threaten a Sino-American
trade war cannot be ruled out. After all, it is the Chinese
year of the tiger.