by A.M.S. Fatemi

Posted on April 12, 2010

Unexpected and sudden improvement in the Chinese-American relations has become one of the most interesting developments of the past few weeks. There might be just as many political horse-trading in this interesting development as there are economic causes. In this brief note we shall confine ourselves to the economic factors involved and leave the international politics for our colleagues at AGIRD to untangle. As reported by the economic and financial press over the past few weeks, the word had gone out that on April 15th of this year, Mr. Timothy Geithner, US Secretary of Treasury, in his formal report to the US Congress will declare China a currency manipulator thus opening the way for legislators to impose tariff sanctions against her. Whereas such a move would have been declaration of quasi-economic war, its temporary avoidance, or at least postponement, gives diplomacy a chance to engage the two sides and search for a solution to the problem.

What is the problem?

For some time the US as well as China's other trade partners have been alleging that China artificially keeps the value of its currency, the Renminbi, low in order to make its exports cheaper and its imports more expensive. If proven, such a policy would give China unfair trade advantage. Of course implementing such a policy would be impossible if China would agree to let its currency freely float like the US Dollar, the Euro, the Yen or even the Russian Rubble. In today's globalized business world practically all major economies have accepted to let market have a major say in how their currency is priced. Since the breakdown of the Bretton-Woods system and abandonment of fixed exchange rates,  it has been possible for some developing countries to keep their fixed exchange regime but, China which boasts as the third if not the second most important exporting country, can hardly continue to claim that status. Therefore, the pressure on China by not only the US, but all her major trading partners including Japan and the EU to let its currency rise.

What Makes China Grow?

Mr. Geithner and Lawrence Summer, one of the main economic advisors of President Obama, maintain that China's inflexible exchange rate has made it difficult for other emerging market economies to let their currencies appreciate and make the global rebalancing possible. Interfering with the market, for whatever reason, always creates more problems than it solves. China has chosen to manipulate its currency in order to use its exports as the main engine for its phenomenal economic growth rate. The same policy has forced unemployment on its trading partners who are not able to export as much and are faced with current account trade deficit. As this debate is temporarily simmering down, China has reported an unprecedented deficit in its latest quarterly statistics on its balance of trade account and may try to use that as an excuse to prove that its currency is indeed not underpriced. This one-time aberration may work as a negotiating tactic but would be hard to sell as a valid argument.