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U.S. Needs Patience, not Threats, to Address China Currency Appreciation

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U.S. Needs Patience, not Threats, to Address China Currency Appreciation
10 Aug 2010
World Politics Review

Few pages in the American political playbook have proven more resilient over the last decade than blaming China's undervalued currency, the yuan, when the U.S. economy sags. When Beijing announced last month that it was unpegging its currency from the dollar and implementing a more flexible exchange rate system, it came after more than a year's worth of constant but unsuccessful pestering from Congress and the Obama administration. Now, with more than a month of this new "flexible" regime in the books, American politicians are unimpressed with the yuan's paltry appreciation against the dollar, and are once again calling for trade sanctions against China. But two examples from the recent past reveal that patience outperforms bluster when it comes to addressing Beijing's currency policy.

The notion that Beijing keeps its currency undervalued became a politically salient issue in the U.S. during the early 2000s. Then, as now, the basic argument was the same: The artificially weak yuan acts as a trade subsidy for Chinese goods, making them more competitive in the American and global market. With the U.S. hemorrhaging manufacturing jobs, China's currency became an easy target for politicians eager to give constituents someone or something to blame. Additionally, American politicians have argued that this monetary distortion results in significant global imbalances. Countries like the U.S. run huge trade deficits, while export-led economies like China run huge trade surpluses and then loan the resulting cash reserves back to deficit economies.

Since the People's Bank of China announced that it would allow the yuan to "float" within a specific range on June 19, it has appreciated less than 1 percent against the dollar, the currency to which it had been pegged for nearly two years. This has angered members of Congress, even though part of the bank's announcement also said that Beijing would still tightly manage the exchange rate, and despite other indications that appreciation would take place slowly. Already, members of the House are planning to debate legislation labeling China as a "currency manipulator" in order to pave the way for trade sanctions, and have scheduled a September hearing on the matter.

Unfortunately, all this grandstanding has little effect on China's foreign exchange policy. Indeed, Congress would be wise to follow the lead of the Treasury Department, which stopped short of using the "m" word in their latest report on exchange rate policy. The last time China faced such serious criticism about its exchange rate policy from the U.S. was during George W. Bush's first term. Then, too, China had been maintaining a de facto peg of the yuan to the dollar, a policy that the U.S. charged kept the currency undervalued. Not long after taking over as Bush's new treasury secretary, John W. Snow made attacking the yuan a central part of the administration's foreign economic strategy. For more than two years, Snow rarely missed an opportunity to call out Beijing on the issue. And for two years, Snow's words had no effect on Chinese policymakers.

Then, in May 2005, as Congress was vowing to impose punitive sanctions against China, Snow announced he had inside information suggesting that China was about to implement a more flexible exchange rate regime. He urged Congress to be patient and give their trading partner a little more time. Less than two months later, the People's Bank of China removed the peg and allowed the yuan to float. The immediate events that followed mirror what is happening today.

By September 2005, American policymakers were seriously underwhelmed by the yuan's appreciation, a measly 2 percent to that point. Running out of patience, legislators began calling for tagging China with the "manipulator" label, and began moving two anti-China bills through Congress. Despite these threats, China continued with the slow and orderly appreciation of its currency. As has been pointed out elsewhere, the yuan only gained 3.5 percent against the dollar during the first 12 months of the managed float that began in 2005. But, the following two years saw it rise more rapidly, and it ultimately climbed a significant 21 percent against the greenback in a three-year period.

This period of appreciation might have continued longer were it not for the global financial crisis. As international financial conditions worsened in 2008, China once again installed a de facto dollar peg, saying that during such uncertain times, its role was to provide a stable currency in a decidedly unstable global economy. Of course, many American policymakers dismissed this as cheap talk hiding China's real motivation: to maintain export competitiveness. But again, recent history suggests China's motivations might not be as nefarious as some suggest.

Though rarely mentioned in today's anti-yuan climate, in the late-1990s, as East Asia was dealing with the last major financial crisis, China famously resisted devaluing its currency even though, at that time, it seemed overvalued. As its neighbors in the region were forced to devalue, China maintained its exchange rate, effectively making its exports less competitive. At the time, this move was greatly appreciated by the U.S. But American policymakers apparently have short memories.

As these examples suggest, China has never based its currency policy on threats from American politicians. Quite the contrary. Beijing, it seems, has always valued currency stability and orderliness above just about all else. Make no mistake, the yuan will appreciate over time. But, it will not happen overnight. And, it won't appreciate because China is taken to the woodshed by Congress or the president, which will only antagonize America's No. 2 trading partner. The yuan will rise because revaluation is in China's interest, as an overheating economy and inflation fears continue to be a real problem for Beijing.

Browbeating China over the yuan won't produce any tangible economic results for the U.S. But then again, U.S. policymakers may want to take their shots now. Because when the yuan does ultimately rise, they'll have to find a new scapegoat for America's economic woes.

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