Wen the going gets tough..
The Sino-US bilateral ties reached a new low recently when the US Senate introduced a bill that aims to put pressure on China to let its currency appreciate. Some members of the US congress even threatened to impose duties on some of Chinese exports, if Beijing fails to revalue its currency. US lawmakers as well as economists argue that the Yuan is at least 20-40% undervalued and is thus affecting the competitiveness of US trade.
Though the debate on Yuan is a pretty old issue, the February trade numbers probably led to the sudden flare in tones. After having fallen by more than 15% (YoY) each month on an average in the last 12 months, Chinese trade surplus with US suddenly shot up by 36%YoY during the month of February. To add to this, the Chinese premier Wen Jiabao on 14th March strongly defended the country’s foreign exchange policy and said that the foreign pressure on revaluing its currency was unfair. He also went on record saying that Yuan is actually not undervalued.
Arguments in favor of US:
· Why would the Central bank keep buying an average of USD50bn every month? And what would happen if this stops and the Yuan is not managed?
· If actually the Yuan was not undervalued then why not let it settle down at this level under a free floating regime?
· Now that the worst of the recession is over and that the Chinese economy is growing at a rapid pace, why would one need to keep the currency pegged? Obviously insulating exporters from the external turmoil does not seem to be a good enough argument now.
· The World Bank adds that given the recovering exports and a rising inflation, an appreciation of the currency would actually help lower the price of imports thereby taming the inflationary pressure.
· Bottom line: The current USD140bn trade deficit with China, which was more than USD160bn at some point in 2008, hurts. A currency peg is facilitating this by giving an unfair price advantage especially in the current state where the US economy is struggling to come out of recession.
Arguments in favor of China:
· Foreign countries may desire to raise exports, but why at the cost of depreciating its own currency? And why try to attempt to pressure others to appreciate their own currency, for the purpose of increasing exports?
· During the period of currency appreciation between July 2005 and September 2008, when the Yuan was allowed to appreciate by almost 16%, the US trade deficit with China actually deteriorated by more than USD100bn. Hence an appreciation of Yuan may not have any impact on US’s trade balance.
The interesting twist to the entire story is that China (private and public) is the world’s biggest holder of US Treasury debt, nearly USD900bn (1/4th of total) and holds about USD2.4trn of foreign exchange reserves, out of which around 1.7trn is believed to be in dollars. Obviously China would not want the value of dollar to come down. On the other hand, when China cut its holding of US Treasury securities by around USD50bn during Nov 09 – Jan 10, it sent a panic to the financial world, about what would happen to the dollar, if China starts dumping their US holdings. Evidently, the stakes are pretty high on both sides.
The bilateral relation has also been tested recently over new US arm sales to Taiwan and President Obama’s meeting with Dalai Lama in the White House. The world can only sit and watch the changing dynamics of the bilateral friction between the world’s largest creditor and debtor.
