Beijing, Bernanke, and the rising yuan

The media and the blogosphere have been alive this week with Treasury Secretary Henry Paulson and Fed Chariman Ben S. Bernanke’s trip to Beijing. Washington still feels the best way to quiet the clamor over the trade imbalance with China is to pressure Beijing to raise the value of the yuan. This week’s Economist chimes in arguing that revaluation of the yuan is not the solution that American policy makers seem to believe and furthermore might have unintended consequences both in China and in the US.

Mr Paulson has taken the rather unusual tack of pleading with the Chinese to come to his aid against protectionist factions in America. Citing “resistance in both our countries to greater integration into the global economy”, he called for tangible results “on the most important issues facing our nations.” This is code for allowing the yuan to appreciate, and other measures to rein in the massive trade imbalances between the two countries. China’s cheap currency is the prickliest issue, at least in the public mind. A Democratic senator, Chuck Schumer, along with a Republican, Lindsey Graham, have been pushing a scheme to slap penalties on Chinese goods if China’s currency is not allowed to appreciate. Given the composition of the incoming Senate such actions are, worryingly, starting to look more possible.

But China’s leaders have big political concerns of their own, notably the millions of underused workers in state-owned firms, and the huge numbers each year who join China’s workforce. A booming export sector is helping to absorb many of these workers, so the last thing China wants is to slow sales of its goods abroad. Nor would the government be at all inclined to defer to the demands of China-bashing American politicians. In her statement to the summit, Ms Wu said that America misunderstands the situation in China, and that change is coming as fast as it can. The yuan has already been allowed to appreciate by about 6% since the middle of last year, which is more than many observers expected.

But Messrs Paulson and Bernanke say that letting it rise further will benefit China as much as the United States, by putting its growth on a more sustainable footing. China’s economy grew by 10.7% in the first nine months of the year, fuelling worries about inflation and an overheating economy. Given the fragile state of many Chinese institutions, particularly its banking sector, an unsustainable boom could lead to a nasty bust, which would please nobody except possibly Ohio’s steelworkers.

Still, the very fragility of those institutions limits how quickly China can move. No one is quite sure what a big and sudden shock to the system would do, and they don’t particularly want to find out. And at any rate, letting the yuan appreciate might not help as much as everyone fancies. Much of China’s manufacturing consists of assembling parts made elsewhere; a rising yuan would make those inputs cheaper, limiting the price impact on its exports. Moreover, the American economy seems to be relatively insensitive to currency fluctuations, which means that it will probably take more than a somewhat cheaper dollar to adjust its enormous current-account deficit.

Admittedly I’m not an economist. I got into the history game because, in the words of Chevy Chase/Gerald Ford, “I was under the impression there would be no math.” But on a personal note, as part of a couple who receives grant support and fellowships in dollars and euros respectively but must pay our bills and rent next year in RMB, I’m not crazy about watching the yuan rise any faster. In the words of St. Augustine, “Lord, grant me chastity. But not yet.”

cross-posted at Jottings from the Granite Studio

The Discussion: 7 Comments

I tend to agree with the Economist’s position. Revaluing the yuan won’t shrink the overall trade deficit. China is already losing export business to Vietnam and other even lower wage developing countries. The last time I went shopping, I noticed varied countries of origin on the labels of clothing and other non-electronic consumer goods. China still seems to dominate electronics manufacturing.

I don’t know if there’s a National Buy Nothing day in the US, but I’d like to start one and expand it to a week.

December 16, 2006 @ 5:58 am | Comment

I sit on the fence and watch knowing that there’s not a lot I can do about the situation and take what comes. I’m a Brit working for a US company and we do all our transactions in USD and RMB, but I’m paid in GBP 🙂 When I came to China in early 2001 the fx rate of RMB:GBP was only about 10.5. It’s now over 15 and it’s been as high as 16. As long as I’m China – vive la pound.

December 16, 2006 @ 11:00 am | Comment

I am in much the same boat. I get paid in USD. Luckily, all of my lifelong savings (what’s left after twi ex-wives) was in RMB. Last year and this were a big knock for expats living in China.
I would (not normally) agree with PiPi. The British Pound is the best investment in my opinion, as far a currencies are concerned.

December 16, 2006 @ 1:06 pm | Comment

The economist also writes about the exchange rates that the politicians should be worried about instead of the Chinese one.

December 16, 2006 @ 1:10 pm | Comment

When I got here and started collecting my meager salary in RMB, I was all for a rising yuan. More money, I thought. Simple equation. But with the dollar taking it’s little nose-dive last week I’m starting to worry about the also-meager savings I left in US accounts.

At this point, I don’t really know what I should be hoping for here.

One thing I tend to agree on: Whatever China’s currency does, it probably won’t make Congress start living within its means or stop borrowing from Asian banks.

December 16, 2006 @ 2:57 pm | Comment

It’s not only Congress that needs to start living within its means but also the American people.

December 16, 2006 @ 9:36 pm | Comment

This is my only observation on this: back when the US companies were into their “earnings-restatement” phase, the market wrote down everything by 20%. That was how much the value of companies went down. That was the level of confidence.

This year, the Chinese admitted in a one-time restatement that their entire economy was 20% bigger than they had been letting on. And the market wrote THAT down verbatim. And that was that level of confidence.

The weird thing is that the Chinese are following the (supposed) American playbook, while the Americans still have faith in the Chinese playbook – that is, that an infinite amount of money can be squeezed out of labor and production costs, leaving enough margin to continue to offer “low prices” on products that really are more and more sizzle and less and less steak.

December 17, 2006 @ 12:24 pm | Comment

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