Research

China's controlled currency

Is the Chinese currency undervalued? If so, by how much, and how does this impact global trade? "That's a profound question," said one expert at "The Currency of Trade," a forum convened recently in Beijing, hosted by Arizona State University, the Kearny Alliance and Tsinghua University. China maintains strong growth, but economies around the globe are still struggling up from the international financial crisis. With the U.S. as one of the major participants in the financial crisis of 2008-2009 many question how long China will keep its policy of minimal currency adjustments (currently at the rate of about 6.8 yuan to US$1).

2010-03-23

Is the Chinese currency undervalued? If so, by how much, and how does this impact global trade? China's growing economic power has been accompanied by questions from politicians, economists and business people about the appropriate value of the Chinese currency. China's boom in exports, especially to the U.S., has brought allegations that the trade balance between the world's two biggest trading partners would not be so out of balance if the yuan were more "reasonably" valued.

Many specifically blame the U.S. trade deficit with China on manipulation of the yuan by the Chinese. A decade ago, following the Asian Financial Crisis of 1997-98, trading partners pressured China to float its currency. China did peg its currency to the dollar, but at a rate that is changed periodically in very small increments by China's central bank rather than being allowed to float in an open market.

China maintains strong growth, but economies around the globe are still struggling up from the international financial crisis. With the U.S. as one of the major participants in the financial crisis of 2008-2009 many question how long China will keep its policy of minimal currency adjustments (currently at the rate of about 6.8 yuan to US$1).

"What is a currency supposed to be worth? What is the relevant value?" asked Louis Kuijs, senior economist with the World Bank in China speaking at a trade conference in Beijing recently. "That's a profound question." Contrary to widely-held opinion, he noted, some form of currency control is commonplace in countries around the globe. "I'd say that less than half the world economies are free market."

The currency of trade

These were among the key topics discussed at "The Currency of Trade," a conference recently convened in Beijing, the second in a series on U.S.-China Trade Relations organized by the Kearny Alliance and Arizona State University. This particular conference focused exclusively on currency issue and was delivered in cooperation with Tsinghua University's International Center for Communication Studies.

Speakers focused on the broad question of whether there is an alternative the U.S. dollar as the de facto reserve currency of the world. They also discussed the decline of the U.S. dollar, the way forward out of the global recession, the role of the Euro and the potential for a new, perhaps similarly-modeled Asia-wide currency.

But a great portion of the forum — subtitled "Formulating Stronger and More Sustainable U.S.-China Trade Relations" — focused on the Chinese yuan: its fairly tight peg to the dollar, questions of government control, and the lack of liquidity. "This just isn't sustainable," commented Clyde Prestowitz, Jr., founder and president of the Economic Strategy Institute, and lead moderator of the forum.

He detailed the many negative impacts in the U.S., where a low-value dollar could help America export its way out of recession and tackle the huge trade surplus — if only Chinese consumers weren't priced out of the market for American products because of high exchange rates maintained by Beijing's stubborn peg to the dollar. But stability rather than economic advantage is the main concern driving monetary policy in China, noted He Weiwen, Deputy Director of the China Institute for Open Economy.

He said Beijing officials plan to loosen exchange controls, but in the same cautious manner that marked the gradual liberalization of the currency, which has been traded only a short time. Those new to China may not realize how far the Communist state has come — and how quickly.

Long after opening to the West in the 1970s, foreigners still weren't allowed to use the Chinese yuan or renminbi. Instead, Foreign Exchange Certificates were introduced and remained in circulation until the 1990s. From 1997 until mid-2005, the yuan was pegged at 8.28 to the dollar. Since then, China has allowed only a small measure of movement in the market, and the currency has appreciated by about 17 percent over the past four years.

Collateral damage from manipulation

That's not fast enough, maintained Prestowitz, citing studies suggesting the yuan was still 40 percent overvalued. Keeping a tight leash on exchange rates might help with domestic stability in the short term, he said, "but you have to ask, in the long term, if this benefits China? I think the answer is no." A ramped-up, export-based economy hindered not only domestic consumption but development.

There were also global repercussions, he added: "Look at Mexico, which is really hurting. A large portion of the exports from China that go to the U.S. take the place of exports that really should come from Mexico." Prestowitz worried that Chinese inaction could spark a new trade war — with competing devaluations — similar to one that followed the Great Depression, when countries devalued currencies to export their way out of recession.

Indeed, such concerns are widespread, and heating up. "Senior monetary officials usually talk in code," Nobel Prize-winning economist Paul Krugman wrote in a column published in the New York Times just days after the forum. "So when Ben Bernanke, the Federal Reserve chairman, spoke recently about Asia, international imbalances and the financial crisis, he didn't specifically criticize China's currency policy.

But he didn't have to: Everyone got the subtext. China's bad behavior is posing a growing threat to the rest of the world economy. The only question now is what to do about it." But China experts warn that the prognosis is far from positive. Financial leaders in China worry that raising exchange rates could be disastrous for China.

Doing business in China

Those doing business in China presented a mixed picture of the role of currency controls and constraints common to China. Merle A. Hinrichs, chairman and CEO of Global Sources, one of the world's leading B2B companies, said exchange rates are naturally of crucial concern to thousands of buyers and sellers using his network.

The recent financial crisis had changed the landscape radically, with more businesses looking at some form of hedging to prevent against exposure to currency volatility. In many ways, a stable currency, and firm peg, provided dependability for traders. Dr. Gary Dirks, former China director of British Petroleum, maintained that the heated debate between America and China about the lack of liquidity and free market conditions has often been unfounded in the past, and may still be so.

He detailed how he ran a $250 million joint venture in China, and a company that invested $5 billion in the country. "At no time did the currency or exchange rates inhibit our operation," he said. "We always found ways to get money in or out of the country." William Valentino, vice president for China for pharmaceutical giant Bayer, suggested that fresh thinking would benefit the ongoing American-Chinese currency-trade debate.

"Einstein said you cannot solve problems with the same thinking with which you created them," he noted. "Currency concerns never kept me awake at nights," he said of his decades spent working in China. "Growth of 50 percent, year after year, is what has kept a lot of us here." He urged more creativity and less rhetoric in trade negotiations. "There are always politics involved in economics," cautioned Logan Wright, China director of the consulting firm Medley Global Advisors.

He noted that currency talks "carried a lot of political baggage" on both sides, and sees little relief in the "conflict between gradual change in China, and the expectations of the Americans." In that New York Times piece, columnist Krugman summed up the increasingly impatient sentiment in Washington DC. "Many economists, myself included, believe that China's asset-buying spree helped inflate the housing bubble, setting the stage for the global financial crisis.

But China's insistence on keeping the yuan-dollar rate fixed, even when the dollar declines, may be doing even more harm now." He ended his column: "The point is that with the world economy still in a precarious state, beggar-thy-neighbor policies by major players can't be tolerated. Something must be done about China's currency." That may be the hope in America, but the prospect in China seems to be more of the same.

And, if markets dictate direction, little future relief can be expected, predicted Dr. Michael Melvin, former W. P. Carey School economics professor who is now managing director and head of currency research at Barclay's Global Investors. He pointed out that hedgers and futures contracts indicated minimal movement — about 3 percent appreciation over the coming year. "The markets are betting there will be no change in value of the Chinese currency and very little appreciation next year."

Bottom Line:

• From 1997 until mid-2005, the Chinese yuan was pegged at 8.28 to the dollar. Since then, China has allowed a small measure of movement in the market, and the currency has appreciated by about 17 percent over the past four years.
• Many economists and trade advocates believe the Chinese currency is still greatly undervalued — estimates range from 15-40 percent. This amounts to a kind of subsidy that keeps its products priced low, flooding the world with cheap exports.
• Pressure is mounting on China to revalue its currency and relax state controls to allow greater exchange movement. Otherwise, many worry that competing devaluations, as seen after the Great Depression, could heighten the current economic crisis.
• Chinese officials are more concerned about their own economy and stability. Experts are predicting they will take a cautious rather than radical approach.
• China's currency is not freely traded, but markers such as contract hedging indicate little appreciation is expected in the near-term. "The markets are betting there will be no change in value of the Chinese currency and very little appreciation next year," said Dr. Michael Melvin, head of currency research at Barclay's Global Investors.

Economics