Yuan-dollar peg and its discontents By Ben Lim | Feb 15, 2005 http://www.abs-cbnnews.com/NewsStory.aspx?section==Opinion&OID=h537 Hardly a day passes without meeting friends asking where they change their US dollar to Chinese yuan. They seem convinced that once China revalues or raises the value of its yuan against the dollar, their dollar savings will depreciate. What they don't know is that since the US Federal Reserve lifted interest rates in June, the dollar has been depreciating since then. They were only alarmed when the dollar hit a new low in December against the euro and has fallen against our weak peso this February. It appears that their fear of a likely Chinese revaluation stems from what they read since the US presidential election campaign when both Republicans and Democrats blamed China for the America's "jobless recovery." The persistent demand by G7 members, especially the US, forced China to make its exchange rate more flexible. Accordingly, pressure for China to revalue is due to the US trade deficit with China of about $124 billion in 2003 and $162 billion in 2004. For the past few months China reported that its foreign exchange reserves soared to $609.9 billion in December, from $514.5 in September. This $95.4 billion jump brought the total increase for 2004 to $206.7 billion. And all the while, Chinese authorities continue to intervene in currency markets to maintain the currency peg of the Chinese yuan to the US dollar. The yuan is pegged at 8.27 to the US dollar. Their peg keeps the yuan's value fixed against the greenback and has been the demon of US manufacturers, who assert that the yuan's artificially low level gives Beijing an unfair advantage in global export markets. But Beijing contends that this is due to the US insistence that China buys US Treasury securities to preserve the peg. Of course China is not helped that this acceleration in official purchases is occurring alongside what appears to be a heightened pace of trade deficit deterioration in the US. Worse, the bulk of China's balance of payments surplus of over $100 billion comes from capital inflows which includes foreign direct investment (FDI) of $57.6 billion in 2004, which exceeded FDI's into the US alongside heightened speculative inflows in anticipation of potential yuan appreciation.Right now, no nation plays a more crucial role in keeping the dollar and the US financial system afloat than giant China. The People's Bank of China has let it be known that China increased dollar reserves by $207 billion in 2004, financing nearly a third of the US current deficit, estimated at $650 billion. America's budget deficit is over $400 billion or more than three percent of GDP. This does not include the $200 billion the US borrowed from the temporary surplus in his own Federal Social Security fund. All these developments have led some US legislators to fear that China might eventually overtake the US economy unless China revalues its currency soon. In the US Senate, two US protectionist legislators, Senators Lindsey Graham and Charles Schumer, have sponsored a bill to force China to revalue its currency within six months or face a 27.5 percent tariff on all exports to the US. Both legislators believed that the Chinese are manipulating the value of the yuan. The Chinese, they insisted, are keeping the yuan undervalued against the dollar by 15-40 percent, depending on who makes the estimates. The two senators cited figures from "a major study between 1989 and 2003," showing that trade deficit with China caused the displacement of production that supported 1.5 million US jobs. Accordingly the number of job opportunities lost each year grew rapidly during the 1990s and accelerated after China became a member of the WTO in 2001. Although the study did not cite comparable statistics on domestic production displaced by imports from the US government. Many economists, including Pam Woodall, editor of "The Economist" magazine, disagree with the view that trade deficits are the cause of net loss of jobs. In her view "faster growth in China should mean faster rather slower growth elsewhere too." Others claim that employment levels are determined by macroeconomic policies including monetary and fiscal policies, and most relevant to trade and exchange rates. It is true that trade deficits will cause less employment in manufacturing but it will also lead to the creation of more jobs in non-traded goods as in services, retail trade and construction. The Chinese central bank refused to comment on the bill. A leading Chinese government economist, Zhu Baoliang, told Bloomberg that China wouldn't be swayed into changing its currency policy. "That kind of bill comes up every year and will keep being raised in the future." Long Yonglu, China's chief WTO negotiator, said that China made "no concessions on government's control over the exchange rate after accession to the WTO, which we can ill afford." Many economists who saw the study claimed that it failed to indicate that for as long as the US productive industries are unable to produce quality and inexpensive goods, whether in low or high-tech manufacturing, they will not be able to compete against other countries. US legislators made the same complaints in the early 1970s against Japan, when Japan's economic rise was seen as a threat to American jobs. Indeed when Japan revalued in the 1980s there was no dramatic recovery in the American economy. The study also failed to take into account the practices of US multinational firms when they relocate their industries outside the homeland. US multinational firms have not been motivated by nationalism but entirely by considerations of what competitive advantage they can get from arbitrating such generic factors of production as capital, cheap labor, tax holidays, differences in culture, legal, cultural and political differences. Finally these legislators overlooked the fact that Allan Greenspan of the US Federal Reserve manipulated the value of the US dollar when he slashed the interest rates several times after the US stock market bubble burst. Apart from the bill some lobby groups in the US are planning a series of actions to make the Chinese toe the line. The National Association of Manufacturers, a powerful lobby of American factory owners, plans to urge the IMF and the US Treasury Department to get China to change its currency regime. Chinese Premier Wen Jiabao has criticized the US for not taking measures to halt the dollar's slide and make it clear that China would not revalue the yuan under pressure. Henry C.K. Liu, chairman of New York-based Liu Investment Group, claims that the American protectionist move "is timely as China stands at the crossroads of economic destiny." China could move in "the direction of which will determine if it will be the latest victim of bankrupt neo-liberal ideology or the sole survivor that manages to develop an effective immunity from the deadly financial virus of dollar hegemony that regularly assaults all economies." In Liu's view, China, the most populous nation on Earth, "cannot possibly expect to develop toward world-class living standards by exporting to a rich minority of the world's population. The poor economies' excessive dependence on export to the rich economies under dollar hegemony will perpetuate the maldistribution of wealth on a global scale and put China permanently on the lower end of that scale."Liu pointed out that "the US economy is constructed around a fundamental framework - the almighty dollar, and the firm and virtually unbreakable international support it enjoys. The dollar supports a massive load of public debt, now totaling well over $7 trillion. When Social Security, Medicare, Medicaid, military and government pensions are added in, the total national debt exceeds $51 trillion, according to "Fortune" magazine. It said the amount is five times the gross domestic product. When you add the off-budget items, this year's deficit alone approaches $1 trillion. Derivatives (interest � rate futures, options and swaps) now total $180 trillion. Total US consumer debt is $8 trillion. The US is currently saddled with $38 trillion debt and there is a $54 trillion federal funding gap � the difference between what the government is committed to pay out and what it will receive in tax revenues. If an exit from the dollar were to occur such as in the sphere of petro-transactions, the effect would seriously undermine US global dominance. Indeed many oil exporting countries from Iran to Saudi Arabia to Russia to Venezuela have already gone on public record that they will make an exit from petro-dollars to petro-euro. Many Western economists do not see the revaluation of the Chinese yuan as the answer to America's economic woes. Alan Greenspan, US Federal Reserve chairman and high priest of American finance, warned that revaluation of the Chinese currency could weaken the Chinese banking system, which could in turn threaten the world economy. In a letter to the US Senate he contended that a free float could cause heavy flow of capital out of China. If China is forced to do a hard landing, the US and the rest of the world will feel the jolt. Greenspan added that: "Many in China fear that removal of capital controls that restrict the ability of domestic investors to invest abroad and to sell or to purchase foreign currency, which is a necessary step to allow a currency to float freely, could cause an outflow of deposits from Chinese banks, destabilizing the system." The truth is that as early as 2003 the Chinese have considered revaluing their currency. Fan Gang, director of the National Economic Research Institute at the China Reform Foundation, said the "the US dollar is no longer � in our opinion - is no longer seen as a stable currency, and is devaluating all the time, and that's putting troubles all the time �So the real issue is how to change the regime from a US dollar pegging� to a more manageable reference.. say Euros, yen, dollars � those kind of more diversified systems." But what is holding China from revaluing the yuan is speculation. According to some financial analysts China's forex reserves has increased dramatically since the call for China to relax its currency. For instance, in the last two months of 2004, China's forex reserves jumped to $67.5 billion. There is widespread belief that over $150 billion of speculative money has been poured into China waiting for the government to revalue its currency.China wants to engineer a modest revaluation that will not distort the world economy. If China does revalue, it is likely to change its dollar reserves to gold, euro and yen or currencies of countries that are China's top trading partners. It is unlikely that revaluation will lead to dramatic distortions in the financial market. It is more likely that some currencies would fluctuate in value against the yuan but it will balance out in the end. According to Stanley Jan of Morgan Stanley (MWD), if China adopts this kind of "managed float," it would keep key exchange values, especially dollar/yuan rate stable or at least shifting within five percent in either direction. Such a scheme would not, as some fear, change the makeup of China's $609 billion in foreign currency reserves, 70 percent of which are in dollar assets like US Treasury notes. Most Americans believe that China might sell some of those reserves and invest in gold and euro instead. But given the volume of China's trade today, China has to keep enough greenbacks to do business, for the dollar is still the world's most liquid currency. It is unlikely that China's trade surplus with the US, which is $160 in 2004, would vanish overnight. However, the US is not the only top trading partner of China; China also trades with the rest of the world. Most economists believe that China will likely undertake a managed float, a modest revaluation, and at the same time shifts its dollar reserve to other currencies. This should quiet some US criticism on China's monetary policy. It is unlikely that China's gradual shift to flexible exchange rates would create unwanted tremors in the financial world. China could still keep the yuan in a tight range against the dollar, while giving the impression of a market-based system. For the US economy to be competitive again, the question is not when will China revalue or raise its currency value against the US dollar. But as pointed out by Pam Woodall, China's prosperity has been "built on genuine wealth creation as currently underemployed labor is put to productive use. In contrast, American consumers have been living in never-never land, financing their spending by borrowing against illusory gains in wealth." The US economy "can get truly richer only through increased productivity growth, either from technological advances or from more efficient production thanks to international trade. The same cannot be said of all the "wealth" produced by stockmarket or housing bubbles. ------------------------ Yahoo! Groups Sponsor --------------------~--> What would our lives be like without music, dance, and theater? Donate or volunteer in the arts today at Network for Good! http://us.click.yahoo.com/TzSHvD/SOnJAA/79vVAA/NJYolB/TM --------------------------------------------------------------------~-> �������������������������������������������������������� This is ZESTEconomics. Post economics-related articles and event info to [email protected] If you got this mail as a forward, subscribe to ZESTEconomics by sending a blank mail to [EMAIL PROTECTED] OR, if you have a Yahoo! 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