After several months of increasingly shrill complaints from members of
Congress about the flood of cheap imports from China and the US trade deficit, China has now
taken a major step to complete control over the yuan (renminbi or RMB).
Where it had no control of its national currency during the years it
totally accepted the Federal Reserves management of the dollar through the
link, at 8.28 to the dollar, it has now broken free.
Chinas first step was to appreciate the yuan to 8.11 to the
dollar; but that from now on will move in one direction or another depending
upon its relationship to a basket of currencies of its major trading partners.
This tiny 2.1% appreciation against the dollar will actually benefit the
Chinese economy, because the dollar is now in inflationary terrain, the price of
gold being at $425 oz when it should be under $400.
The move thus
removes that much inflationary pressure from the yuan and reduces the cost of
capital for all yuan transaction, foreign and domestic. It will not harm the US economy in the least, only benefit
China.
It is obvious from the
shape of the new regime that the People's Bank of China has borrowed an idea
from Singapore's central bank, which also
manages its currency against an unspecified basket of other currencies - a
mystery formula that permits it the greatest freedom in seeking the best "money"
for domestic and export purposes.
Mystery basket
In a real sense, where American politicians have been accusing
China of "manipulating" its
currency by rigidly fixing it to the dollar, China can now
really "manipulate" behind the curtain of its own mystery basket. In the 27 July
Wall Street Journal, the deputy director of the Shanghai Stock Exchange,
Fang Xinghai, put it this way:
|
Several other Asian
countries have monetary policies that keep their currencies in line with
the
dollar. |
"China
could have implemented the new currency regime without any initial
revaluation. But the decision to accompany it
with a small revaluation was a clever move that responds to both
China's growing external surpluses
and American demands for an appreciation in value of the yuan.
Since the new basket arrangement aims to
keep China's nominal
effective exchange rate relatively constant, it's quite impossible for the yuan
to appreciate against the dollar by the much larger amount that many
US politicians have demanded, unless
the dollar declines dramatically relative to other major
currencies.
Because
the other major central bankers at least keep an eye on the price of gold, for
signs of incipient inflations or deflations, it would be "quite impossible" as
Fang suggests, for the dollar to decline dramatically against other major
currencies unless the dollar/gold price shot up, above $450 oz, heading toward
$500.
Optimum currency area
This has been exactly the advice China has been getting from Canadian
economist Robert Mundell, who spends much of his time in Beijing and has listed
a dozen reasons why China should resist a "significant" revaluation of the RMB
that have been well-publicized in the Chinese press.
Because Mundell got his 1999 Nobel Prize in economics for work he did on
"optimum currency areas" that led to the creation of the euro, his arguments
carry great weight with the People's Bank of China. The fact he is Canadian also
helps with the government, which is aware of the American advice to Moscow in 1989, the "shock
therapy" that led to the great inflation of the rouble and the break-up of the
Soviet federation.
The idea of an "optimum currency area" or "zone" is that neighbouring
countries or those that engage in significant trade with each other benefit
enormously from using a common currency-which is the effect when China
gives the RMB a value it keeps identical to the dollar. Several other Asian
countries have monetary policies that keep their currencies in line with the
dollar and, ipso facto the RMB, becoming part of this broad trading zone.
Malaysia, for one, immediately joined China in
revaluing its currency by 2.1%. In that sense, Malaysia clearly
signalled that it was joining an RMB zone, moving away from a dollar zone.
RMB zone
An RMB zone? Yes. Unless the United
States ends its own dollar manipulations, which show up in
the serious fluctuations in the dollar/gold price, the Asian economies will
almost certainly move toward a Chinese currency umbrella, providing a superior
"money" that will end the dollars dominance in Asia.
|
In a real sense, where American politicians have been
accusing China of
"manipulating" its currency by rigidly fixing it to the dollar,
China can now really
"manipulate" behind the curtain of its own mystery
basket. |
Money,
remember, is not only a medium of exchange to facilitate trade. It is, even more
importantly, a unit of account that enables domestic and international producers
to draw contracts over time. The superior money is one that holds its value in
real terms over the lives of contracts short and long. When a currency
fluctuates against gold over time, the costs of doing business increase as
interest rates must climb to cover the risk.
In the United States,
my own work shows that between 1945 and 1971, when the dollar was fixed to gold
at $35 oz under the 1944 Bretton Woods arrangement, the real economy in the
US grew by 4% per year. From 1971
when the dollar was floated to 2004, real growth of the US economy has
managed only a pitiful 0.3% per year.
New Bretton
Woods
Unless these inefficiencies are removed with a new "Bretton
Woods arrangement," as Mundell calls it, Beijing, at some point, may decide that the
costs of importing inflations and possibly new deflations outweigh the benefits
of its imprecise currency zone. The intermediate step it has now taken moves it
toward a fixed yuan/gold price. You might easily imagine the implications of
this development.
Chinas economy is not yet big enough or secure enough to take
on an international banking role, but at current growth rates relative to the
US, it could rival the
US economy in several years. With a
convertible currency in the near future, it could take the next step toward
fixing the yuan/gold price instead of importing its monetary policy from one or
several other nations.
It would be natural for Japan to break away from its currency zone with
the US and join
China's, as its trade with
China continues to exceed its
trade with the US.
Malaysia's Mohammed Mahathir had dreamt of pulling Islamic nations
out of their dependence on the dollar by joining in a fixed rate system among
them, behind a gold dinar. As his success has been limited, it may be that
China will get there first. Not this
year or even next, but sooner than later.
Jude Wanniski is a former associate editor of The
Wall Street Journal, expert on supply-side economics and founder
of Polyconomics, which helps to interpret the impact of
political events on financial markets.
The opinions
expressed here are the author's and do not necessarily reflect the editorial
position or have the endorsement of
Aljazeera.
