Three giant trading blocs account for more than one half of the value of world’s trade at current prices. The biggest is the European Union (EU-15) whose intra-trade in 2001 was worth $1,418 billion. The second is Asia (a bloc that excludes Japan and Australia, but includes Greater China—Taiwan and Hong-Kong— South Korea, Singapore, Indonesia, the Philippines, Malaysia, Thailand, Vietnam, Laos, Mongolia, Cambodia and Brunei); in 2001, it had $722 billion in intra-trade. The third in importance is the North Atlantic Free Trade Association (NAFTA) consisting of the US, Canada, and Mexico), with $637 billion in intra-trade.
The 2001 figures also showed that inter-bloc trade was significant, though seriously imbalanced. A few numbers suffice to encapsulate that imbalance but, given the importance of the three blocs, it poses a threat to the whole trading system. In that year, the EU posted a $66.6 bn trade surplus with the NAFTA, and a $59.0 bn deficit with Asia. On the other hand, the NAFTA had a $281.5 bn deficit with Asia, which, in contrast, posted a warping surplus of $340.5 bn with the other two. Of course attention is now turned toward Asia. And China, the heavyweight in that bloc, is accused of keeping its currency, the renminbi, deliberately undervalued.
According to the accusers, if China could only reevaluate the renminbi from anywhere between 30 or 40 percent, trade balance would be reestablished. This is what the G-7 countries, to which China does not belong, seem to believe. The fact is that the Central Bank of China has pegged the renminbi at 8.28 to the U.S. dollar since 1994. But, in view of the trade surplus that China is now generating, the G-7 countries, mainly under the influence of the U.S. Treasury, have concluded that the renminbi must be undervalued. Consequently, following their meeting in Dubai (in the United Arab Emirates) on the weekend of September 20, 2003, they called on China to please adopt a policy of flexible exchange rate. This was the diplomatic language used. What was not said, but really meant was: “Economic growth in the EU is sluggish. The U.S. economy has lost some 2.9 million jobs over the last three years. We have exaggerated the figures to show a robust recovery, but it is jobless; that must be your fault. Moreover, your currency must be undervalued, so let the market set the rate of exchange right, or else …”
To see the logic behind the call, it suffices to consider a simple example. Suppose that the Chinese Central Bank were to reevaluate the renminbi by, say 18.2 percent, that is, by lowering the exchange rate from 8.28 to 7.0 to the US dollar. Chinese exports to the US and the EU would cost 18.2 percent more, while US’s and EU’s exports to China would cost 18.2 percent less. We would then hope that foreigners would buy less of Chinese goods, while Chinese would consume more imports, thereby reestablishing the sought-after balance. This little example can surely shed much needed light on the logic but not on the true nature of the imbalance. What was at stake in 2001was that the EU had a net trade surplus of + 7.6 bn, the NAFTA had a net deficit of $–348.1 bn, and the Asian bloc had ended up with a net surplus of + $340.1 bn. Notice that Asia’s and EU’s surpluses summed up to the deficit of NAFTA, which incidentally represented some 88 percent of the US’s deficit on current account in 2001. To achieve balance, therefore, either Asia had to revalue, or the NAFTA had to devalue the dollar. Of course, nothing was done, and the imbalance kept on increasing ever since. But since it is “either reevaluation in Asia, or devaluation in NAFTA,” why then are the big boys picking on just China, principally now when it is a full member of the WTO?
I suspect that it is because China appears as an easy target. Together with Kong-Kong, China had attracted some 41 percent of the total direct foreign investment allocated to emerging markets in 2002. During the same year, China’s industrial output rose 16.5 percent, its exports rose 33.4 percent, and had accumulated a trade surplus of $103 bn with the US alone, according to US figures. The accusers seem to believe that China could not have accomplished such a feat unless its currency is deliberately kept undervalued. They have further reasoned that if they haul China into the court of public opinion, mention the level of its dollar reserves and the fact that this year it spent close to $27 bn purchasing dollars to support the peg, their case would appear compelling to the jury. Is it, or is China then guilty as charged?
I am not so sure. But, before jumping to a conclusion, I guess that any good lawyer would want to take a look at the accusers themselves. Behind the G-7’s call to revalue, it is rather surprising to find the Japanese business sector to which Chinese growth represents a life support system. This year, China has already taken $5 bn worth of Japanese exports. Beside, Japan itself is buying dollar like crazy. As of last year, it accounted for 45 percent of the total dollar reserves in the region; Hong-Kong, Singapore, South Korea, and Taiwan together accounted for 27 percent. During the last 5 and one half years, Japan has accumulated $527 bn, while China with $347 bn accounts for only 32 percent of the total accumulated in the region.
For sure, not all is well in the Japanese economy. After its banking sector blew about one trillion dollars in the Asian meltdown in 1997–98, Japanese consumers have lost their appetite. And since government policy has not succeeded in reviving real domestic consumer demand, Japan is counting on foreign demand to spur economic growth. Hence, the Japanese Central Bank, for quite some time now, has been buying dollars in an attempt to keep the value of the yen between 115 to 120 to the dollar. According to l’Union des Banques Suisses (UBS), Japan purchased up to $39 bn to that effect last year, compared to China’s $27 bn. In addition, the recent rise in Japanese export growth is entirely due to Chinese growth. Hence, the position of Japan in the indictment appears indeed very weak. It is just like blaming someone for something that you are yourselves doing. The prosecutor should not take such a plaintiff seriously.
The other main plaintiff is the U. S. Manufacturers Association. US multinationals are stumbling on each other to invest in China. They have been using China as an outsourcing base to avoid higher production costs home so as to ensure their own profit rates. Just this year, their assembly lines have already accounted for some 22.3 percent of China’s rise in exports. And they are not alone in this, the other Chinese provinces of Taiwan and Hong-Kong, and other Asian countries such as Singapore, Malaysia, etc. have been contributing to the rise of Chinese exports by shipping ex-Chinese ports. The fact is that US businessmen are the main beneficiaries of the present situation. And here they are, hiding behind politicians to point fingers. The sad truth is that their strategy seems to have found adherents home. More than 60 members of the House of Representatives have recently sponsored legislation that would impose tariffs on Chinese imports should the Treasury decide that the renminbi was deliberately kept undervalued. A certain Richard Durbin of Illinois and five other senators are preparing a bill that would levy a 27 percent tariff on imports from China if the latter refuses to adjust its exchange rate. And this is not all. The US-China Economic and Security Review Commission, set up by the Congress to assess relation between the two countries, has followed suit, charging China with violation of WTO and IMF rules by “manipulating its currency for trade advantages.” Here too, even if the prosecutor had not noticed, the jury should be a bit leery of the motive of that plaintiff.
Let us now briefly examine the merit of the charge. First, the US Secretary of the Treasury has asked China, not Japan, to adopt a flexible exchange rate regime. But the decision to let one’s currency float is the embodiment of the absence of a policy. Hence, the Chinese Central Bank here is justified in ignoring such a suggestion, as a policy of no-policy is to do nothing.
Second, the renminbi is pegged to the dollar since 1994; what is this business of “letting the market set the rate” or “manipulating the currency”. Every central bank has a monopoly on its exchange rate policy. The market determines rates only in the absence of policy. Then, how can one call on China either to adopt a policy of no-policy, or ask it to stop fumbling an exchange rate that is fixed for almost 9 years? Frankly, such ignorance on the part of our politicians is embarrassing. The prosecutor should send them over to take macro-101 before involving themselves in the quagmire of exchange mechanics.
Third, if the renminbi is undervalued with respect to the dollar, the cause of the surplus, it must be so with respect to the yen, the euro, or to any other currency. Yes, China has a huge surplus with the US, but it posted a $75 bn deficit with the rest of the world in 2001. As its imports were growing more rapidly than its exports, that deficit must have grown, and will continue to grow in the future. The big question here is, why would the renminbi be undervalued with respect to the dollar, while overvalued with respect to other floating currencies? In fact, we do not even know the true extent of the imbalance, because data on financial transactions are notoriously inaccurate. For example, Chinese surplus figures appear grossly under-stated, and US’s deficit figures are over-stated due to re-exports from Hong-Kong. This is further exemplified by the 2003 IMF estimate of a world current account deficit of $180 bn; a figure that should be zero.
Fourth, China, with its huge population, must provide between 30 and 40 million jobs per year just to stay on a sustainable path. In truth, the growth of its economy is not only helping China, but many others as well. It is sustaining Japanese growth, as already noted. It is supplying American consumers with relatively cheap goods, keeping an undervalued inflation at bay, and transferring a handsome profit to American multinationals. And it is pulling the Third World economies, as China is a huge importer of steel, oil and other raw materials, and foodstuffs. A reevaluation of its currency stands to hurt many.
Finally, China competes in terms of lower production costs, technology and quality control. I guess that that is the main reason why other Asian countries are sending their goods to China for completion before export. Under these circumstances, a reevaluation may cause a chain reaction in currency realignment in Asia, risks a bubble in property values in China, and invites speculators to prepare for the next re-evaluation.
In sum, the accusation of cheating is not supported by economic facts. Indeed, the Chinese surplus problem and all the commotion seem to be more American-made than are the result of Chinese behavior. As already noted, American multinationals invest outside of the US. The U. S. Government is running bigger and bigger fiscal deficits. American consumers are addicted to consumption. And neither group saves enough to finance domestic investment. If the US were to shut up trade with China, it would have to call on other nations to finance its steadily growing current account deficit. While it is true that, under the terms of China’s entry into the WTO, the US has broad discretion to impose emergency tariff on any Chinese goods that it has identified as being produced or commercialized under unfair conditions. However, a duty on Chinese imports is not only a tax on Americans but also an impediment to Chinese exports to which China is likely to retaliate. And it can do so on two fronts. China is the second largest buyer of U.S. Treasury bonds. Should it decide to dump its vast holdings of bonds, it could put serious pressure on U.S. interest rates, and hurts the U.S. recovery, and it could also retaliate with sanctions of its own against US exports.
There is another important aspect of this debate to consider. A reevaluation of the renminbi is a devaluation of the dollar. As foreigners are significant buyers of U. S. assets and equities, such a devaluation could discourage foreign investors from financing the US current account deficit, and that would put pressure on US’s interest rates, consumer prices, and unemployment. Moreover, the EU-15 has already borne the brunt of the dollar’s depreciation; hence, it is unlikely to take a devaluation lying down. The European Commission has already won WTO authorization to impose retaliatory sanctions on US imports for illegal tax breaks granted to US-based exporters, and tariff on foreign steel. The US too has filed a grievance for EU-15’s refusal to accept genetically modified crops. So far, the EU-15 has not imposed these retaliatory sanctions because it did not want to antagonize the US prior to the Cancun meetings. But, it may now do so if felt provoked by a dollar devaluation. The US, for its part, may win its case on GMO’s and hit back with sanctions of its own, fueling a little trade war that nobody seems to want.
In the light of these, I guess that any reasonable jury would find China not guilty, but it would have to be careful not to conclude that the problem is unreal. It is, except that I do not think that it can be resolved by arbitrary currency realignment. Such realignment would help neither China, nor the rest of Asia, nor the Third World. The US, for its part, owes almost $3 trillion to the rest of the world. A fall in the dollar might help the current account, but hurts the capital account. Because if foreigners, who hold a big chunk of US assets, get the impression that the dollar is about to be devalued, they will immediately hedge or dump their holdings. Moreover, a devaluation will certainly hurt the feeble recovery of the euro zone. It will hurt developing countries that are all dependent on the U.S. market. It might also cause a rise in U.S. interest rates, and administers a blow to the bond market. This is perhaps the reason why the U. S. position on the issue is rather ambivalent. It publicly subscribes to a strong dollar policy, because it knows that Asian central banks, including the Japanese one, holding some $2 trillion in reserves will not allow the dollar to fall. The main reason is that Asian central banks are good students. They have paid heed to US’s authorities and other ideologues’ sermons to the effect that an export-led strategy is the optimal path to wealth creation.
At this point, it seems reasonable to suspect that the true nature of the imbalance is the lack of growth in the G-7 countries. The economic growth rate in the euro zone is a mere one percent; this is clearly not enough. Some would want us to believe that this is due to the lack of reform. But that will not do. Not long ago, every country in the euro zone had to painfully reform so as to meet the requirements of the Maastricht Treaty, and reform there was. I would rather believe that waste due the to dot.com and telecom bubbles, and the obsession of the European Central Bank to fight an invisible inflation have more to do with sluggish growth in the EU than anything else.
In the US too, growth was sluggish until the second quarter of 2003. There, the authorities have made the conscious decision to engage in new military adventures rather than doing their own reform. Recently, the U.S. Commerce Department revised its estimate of annual growth in the second quarter to 3.1 percent. A closer look at the number shows that some 55.6 percent of that figure was due to a big rise in military spending. Another big chunk, 43.9 percent, came from hedonic pricing. Hedonic pricing is a trick used by government statisticians to value today’s investment in computers at 1996 prices. In a recent article in the Financial Times of September 5, 2003, Kurt Richebaker, after correcting for hedonic pricing to make the figures comparable to international standards, concluded that actual real growth rate was 1.68 percent. Of course, that was not enough for a locomotive economy, which is now dependent on asset inflation to fuel its borrowing and spending. If the third quarter shows that a serious US recovery is under way, that may solve the problem.
What then is really behind this clamoring for renminbi re-evaluation? To me, at least, the answer is simple. During the last decade, China has been posting phenomenal growth rates. Since the busting of the bubbles in the two other competing blocs, China has registered growth rates of 7.3 percent in 2001, and 7.5 percent in 2002, and is expecting a comparable figure for 2003. Asking it to revalue is a subtle way of attempting to transfer its growth outlook to those who had been wasting their own resources.
• The author is a former Professor of Economics.