Why China doesn't want appreciation...

of the Yuan The grinding message from US and EU politicians and media commentators is that China, by pegging the yuan to the dollar, is putting up a trade barrier. China has the trade surplus, US and the EU have the trade deficit. The US and the EU want China to revalue its currency to make Western imports to China cheaper and Chinese exports to the West more expensive. When the position is stated in such simplistic terms the proposition is laughable. However, arguments are usually deployed to show that it is in everyone's interests to allow the Chinese currency to 'float'. The arguments would be fair enough if the West was also willing to move away from its international restrictive practices and if it had a greater appreciation of the time it will take China to correct its internal market distortions before it can allow its currency to float freely. China cannot even hint that it will allow appreciation otherwise it will attract even more foreign investors (speculators?) in yuan assets.

The US in particular has never been able to completely relinquish protection of its key industries such as steel and agriculture and many other products, like tyres, which have annoyed the Chinese. The EU puts up tariffs on textiles and food. Since 1992, China's tariffs have fallen from 40 per cent to just over 5 per cent today. China has also agreed to be bound by WTO regulations on tariffs but faces the discrimination by what Will Hutton calls the WTO's "grievous deficiencies in their accountability, representation and mandate." He comments that during the behind-the-scenes 'green room' process of the WTO a common position is brokered between the EU and the US which he calls "an affront to the rest of the world."*

The Chinese argue that the stability of the Chinese currency has been vital during the recent economic crisis and their purchases of US treasury debts have effectively keep the US afloat. As the China Daily leader writer recently observed: "A revaluation of the yuan will not only result in a capital loss for China's holding of US treasury debts but also discourage future purchase of such US bonds." Last week it was revealed that China significantly reduced its holdings of US Treasury bonds and, if that continues, the US will quickly quieten its calls for yuan appreciation. Geng Xiao, director of the Brookings-Tsinghua Center for Public Policy in a recent interview argues that it’s not in China’s interest to dump the dollars that they are holding because "China actually benefits tremendously from the two-way capital flows... which helps to improve China’s investment efficiency. The problem is that the US has this authority as a global currency. But US monetary policy is entirely focused on the domestic policy and the domestic unemployment."**

As China moves resources towards boosting domestic demand it is likely to allow for a gradual appreciation of the yuan, but the government has to exercise a fine control over bank lending which has been growing at a worryingly high rate in recent months gving rise to the risk of inflation and debt defaults. The government has just instructed banks to reduce their lending conscious to avoid the mistakes of Western economies. Olivier Blanchard, the IMF's chief economist, struck a more balanced note in Washington on 15 February when he said that a discussion on China's macro-economic policy should start with the savings rate and not with the exchange rate.

This is a story which I think will become increasingly important to follow during the rebuilding and restructuring of the global economy.

*Will Hutton, 2007, The Writing on the Wall, Abacus, London, p.351.
** Geng Xiao interviewed in the McKinsey Quarterly, February 2010.