Wednesday, June 23, 2010

Doubts mount over impact of Beijing's yuan reform

Business Times - 24 Jun 2010

Doubts mount over impact of Beijing's yuan reform


FOR close to a year, Obama administration officials have resisted pressure from the US Congress to punish China for refusing to adjust its tightly controlled currency, the yuan. At the same time, US President Barack Obama and his aides, led by Treasury Secretary Timothy Geithner, have been working behind the scenes to persuade the Chinese government to move in that direction.

And now, it seems that Washington's exercise in quiet diplomacy has proved to be successful after China announced on Saturday that it decided to take the yuan off its peg to the US dollar and let it trade freely. The Chinese made the announcement against the backdrop of growing anti-China sentiment on Capitol Hill and on the eve of the summit of the Group of 20 economies in Canada at the end of this week.

The G-20 members have agreed in their last two summits that any serious response to the global financial crisis required an element of rebalancing the global economy - by creating conditions for an end to the huge US trade deficits and Chinese trade surplus. This is what led China to buy US dollars in order to finance the imbalance and encouraged Americans to spend more and borrow more and those two factors made the recent financial crisis possible.

In addition to responding to outside pressure, the decision by Beijing probably reflects concerns that by keeping imports expensive, their weak currency could ignite inflation. And the Chinese may have concluded that boosting their currency was not going to have major impact on their strong economy, especially since the appreciation in the value of the yuan against the US dollar would probably be a very slow process.

At the same time, the Chinese move should be regarded as good news for American manufacturers selling their products into the China market.

In terms of the global financial system, it means that the Chinese are going to start buying more things, consuming more and saving less, while the Americans will mirror-image that behaviour by selling more things, consuming less and saving more. That is at least what economic theory says should happen.

But the response to the Chinese announcement in Washington, and in particular on Capitol Hill was less than ecstatic, suggesting that notwithstanding the theory behind the Chinese move, American officials and lawmakers are not forecasting any dramatic change in Sino-American economic relationship anytime soon.

No one expects the yuan to appreciate by more than 5 per cent by the end of the year. In fact, Senator Charles Schumer of New York, who has been the leading advocate of passing legislation to press China to end what he and his colleagues describe as an official Chinese policy to use its currency to boost exports, have made it clear that he was not impressed by the Chinese decision. And he told reporters that - together with his Democratic and Republican colleagues - he was going to continue pushing for legislation that calls on the administration to brand China as a 'currency manipulator' and threaten it with sanctions.

But Mr Geithner backed away from issuing a report that was required by the Congress in April which would have indeed forced him to label China a manipulator of its currency, after receiving assurances from the Chinese that they would readjust the value of their currency sooner than later.

What Senator Schumer and other lawmakers are actually saying is that they are concerned that the Chinese announcement was meant to appease the US and other governments before the G-20 summit, and that they want to see a speedy and sizeable appreciation of the yuan against the US dollar in the coming months before deciding whether to continue promoting their anti-China legislation.

Congressional Democrats even more than the Republicans are worried that a failure on the part of the American manufacturing sector to increase its imports to China and other emerging economies will make it more difficult to lower the high US unemployment rate and slow down the pace of economic recovery.

That, in turn, would make it more likely that economically distressed American voters would punish the Democrats who control the White House and the Congress in the mid-term election in November this year and perhaps in the general election in 2012 as well.

It seems that investors in Wall Street, after bidding stocks up on Monday in response to the Chinese announcement, have also become more sober about the impact of the yuan decision. They exerted downward pressure on stocks in the rest of the week.

Indeed, it will be a few months before it becomes clear if the yuan will strengthen significantly against the US dollar.

Copyright © 2010 Singapore Press Holdings Ltd. All rights reserved.

No comments: