China and its Currency Under Pressure

The Financial World According to Inya” Column by Inya Ivkovic, MA

One could say that China does not respond well to pressure, especially if the pressure is coming from the U.S. and if it is about finally letting the yuan exchange rate float freely, or as freely as China is capable of letting it. How does China typically respond? Let’s just say that its typical response led to the rift between the country’s central bankers and politicians deepening yesterday.

When two new kids on China’s central bank’s block called for allowing the yuan to continue on its path of measured appreciation against the U.S. dollar, the Commerce Minister Chen Deming hit them with a dire prophesy that, if further appreciation were to be allowed, China’s trade surplus with the U.S. would still be the height and width of Mount Everest, providing little to no help on the front of balancing export receivables and import payables.

The only problem is that the clock is ticking towards April 15, when the U.S. Treasury is supposed to make up its mind whether China is manipulating its currency on purpose to keep a competitive advantage over its exports and to keep its artificially created superior status in global markets. As my 19-year-old son would put it, “Duh!” Regardless of what some may think is obvious and what is not, and if the U.S. Treasury rules China’s foreign exchange policies are indeed manipulative, the next step will likely be for the U.S. legislators to introduce laws that would impose tariffs on Chinese goods. The only thing that might prevent the “Buy American” sanctions against China would be China allowing the yuan to go up.

Of course, neither side can act gracefully, holding their respective guns against each other’s heads. On one side is the U.S. and what China calls its unwarranted threats of tariffs, and on the other is China and what the U.S. calls manipulative foreign exchange and international trade policies. Who is right and who is wrong? The way I see it, neither side is either right or wrong…absolutely. As it so often happens, the truth is in the eye of the beholder.

To be fair to China, it is walking a very fine line between a rock and a hard place. It is still an emerging economy that needs to grow to claim its place in the world. One way to do this is through exports, thus channeling its internal macroeconomics onto the world. To keep its exports competitive, foreign exchange has to be favorable, which means keeping the yuan as low as practicable against the U.S. dollar (to which the yuan is pegged). However, China’s central bank needs a stronger yuan, so it can have one more tool in its shed to handle various economic tremors and/or quakes, regardless of whether they’re already experienced or are still looming ahead.

All of this is happening against the backdrop of China being the world’s largest holder of U.S. Treasuries, which means that, while the U.S. needs to borrow money from the world’s powerful lender, China needs the U.S. to keep on buying its cheap products so it can fund the U.S. national debt. It is a fine line, indeed, and, since the 1970s, China has not walked it alone.

Over the years, tough rhetoric from Washington towards China has yielded little to no results. If China decides to loosen its grip on the yuan, it won’t happen because Washington has said so. In fact, China’s yielding on the currency front to global economic or political pressures is not expected at all, apart from allowing only limited yuan appreciation on the premise that signs of economic recovery are holding and Chinese exports are not jeopardized. For the time being, China is showing little interest in promoting flexible monetary policy, other than on an academic level.