Monday, October 17, 2011

Washington's Frustration with China

Recently, the United States Senate passed the Currency Exchange Rate Oversight Reform Act of 2011.  This act follows allegations by the International Monetary Fund that China is still significantly undervaluing the Renminbi.

The Act states that the Treasury Department will monitor exchange rates between the U.S. and its major trading partners and report to Congress about it twice a year.  It also amends the Tariff Act of 1930 in regards to anti-dumping to establish export prices if a currency is considered fundamentally misaligned.  President Obama has not taken a public position on the legislation, and the House of Representatives' leadership have spoken out against it, so the legislation is unlikely to become law.  Indeed, some might say that a government that devalues its currency as much as the United States does passing legislation against another country that pegs its currency (in part) to the former's currency is a bit like the pot calling the kettle black.

A black pot and a black kettle (photo: Mark Corbin)
Most countries around the world engage in currency manipulation to varying degrees.  Almost all countries have fiat currencies, these are currencies that are controlled by central banks rather than being valued based on a commodity as was common in past times.  The Federal Reserve is an example of a central bank that has sought to weaken its currency in the past couple years.  Some countries that do not have reliable or credible governments or central banks use a system of fixed exchange rates.  China has had a system that tied their currency directly to the dollar.

(source: IMF)

The issue has quite a bit to do with the relative ascendancy of the Chinese economy to the rest of the world.  China has had significant growth in a time when the United States has struggled to maintain positive growth.  Much of their growth has been based on exports which have been helped by their currency's low and steady value.  The Peterson Institute for International Economics has released a working paper that China and Singapore have undervalued currencies, while the United States has an overvalued currency in terms of trade weight.

Shanghai (photo by ふみこ)

These allegations suggest that China has allowed its currency to depreciate, which has not been the case.  China's Renminbi has actually slightly appreciated relative to the dollar, and it has begun to have (slight) fluctuations because of the Renminbi's pegging to a basket of currencies rather than simply to the dollar.  As you can see in the chart below, these appreciations and fluctuations have been minor compared to the 8-14% annual growth that the Chinese economy has had overall.

A lot of this strain is caused by China's policy of continuing to peg its currency rather than let it float with the strength of its economy's.  It is often a positive thing for all countries involved when a developing or unstable country or currency pegs itself to a stronger currency.  It is another thing altogether for a relatively strong economy to do this.  A strong country pegging a currency can cause distortions throughout the international economy.  China is strong enough to stand on its own, and its currency is as well.  They should stop pegging their currency altogether and become an leader within the international economic community.

ED: Here is the People's Bank of China's response:

The xx - "VCR"


  1. Pegging one's currency in order to deliberately devalue it is puzzling. It's like a country-wide tariff, which would have a strictly smaller total surplus (producer surplus plus consumer surplus).

    I think that it's more likely that a floating currency would not price the yuan much differently than it's currently valued. I suspect that China is simply taking precautions to prevent spikes in the currency rates. Not a bad idea if your government is large enough.

    Don't forget that there's a good chance that those GDP numbers are highly suspect.

  2. I would say that RMB was undervalued for quite a lot 2 years ago, but not so much now, given the high inflation since last year.

    As China is growing stronger, the RMB should transit more to float. It would be a long process, with so many economic and political factors to take into account in such a complex country. And Andrew is right about the GDP numbers.... I don't think the economy is as glorious as it appears.

    However, I do consider that Beijing should have made a bolder move in the currency appreciation 2 years ago, as an undervalued RMB will bring more problems in the long run. (Again, the situation is different now.)

    The "Act" that the Oval Office is proposing is more like a political move. It will not help much with the US economy, since RMB is not the cause of the big problems. The White House is simply trying to shift people's attention here.