Wednesday, April 14, 2010

Averting a currency war

Business Times - 14 Apr 2010

Averting a currency war

NEWS reports from Beijing suggest that China may be on the brink of allowing the value of its currency to rise, perhaps by as much as 3 per cent against the US dollar. While a 3 per cent change is relatively small, a deal between Chinese and US officials on boosting the value of China's currency could have important economic and political implications for both the United States and China as well as for the global economy. The expected Chinese currency re-evaluation followed a visit to China by US Treasury Secretary Timothy Geithner last week, a few days before Chinese President Hu Jintao's arrival in Washington on Monday.

One important outcome of a Chinese currency adjustment against the US dollar would be political. It would turn the currency question from a hot-button issue into a manageable problem in Washington. This could help ease pressure on the Obama administration from lawmakers to name China a 'currency manipulator'.

The concern in Washington has been that by unfairly keeping its currency undervalued by pegging the yuan to the US dollar, Beijing has been pursuing a blatantly mercantilist policy and fuelling trade imbalances. At a time of high unemployment in the United States and given America's expanding trade deficit with China, US lawmakers and labour unions had seized on the yuan issue to demonstrate that they were 'doing something' to stand up to Beijing.

But US President Barack Obama and Mr Geithner have wisely resisted the pressure to take a confrontational approach on the Chinese currency issue. Such an aggressive policy could ignite a nationalist backlash in China, and perhaps even ignite a trade war between the two countries.

Rising tensions between China and the United States could also hinder Sino-American cooperation in other areas, including freezing Iran's nuclear military programme, reining in North Korea and dealing with climate change. But while a yuan revaluation could make some American-made goods more competitive versus Chinese exports, a modest and gradual appreciation of the yuan will probably not do much to dramatically reduce the US trade deficit.

In fact, US firms that can't obtain low-cost goods from China - mostly as a result of rising Chinese wages - are already turning to lower-wage countries such as Vietnam and Indonesia. This prompts the interesting question of whether other Asian currencies will also appreciate against the US dollar - which raises several other issues.

There is no doubt that averting a Sino-American 'currency war' was in US geo-strategic and economic interests and that the Obama administration should be applauded for its currency diplomacy. But ironically, the main beneficiary of the yuan appreciation could well be China, which will now have more flexibility to raise interest rates and cool its overheating economy.


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