To Revalue or Not to Revalue,
That is the Question for China's Leaders
by Satya J. Gabriel
This is an early draft of an essay written
for the inaugural issue
of
China Now (successor publication to Beijing
Scene, which was the widest circulation English language
publication in China until the government shut it down.) See
China Now, Vol. 1 Issue 1, p. 21, for final version.
Why do top U.S. economic officials, such as Fed Chair Alan Greenspan and
Treasury Secretary John Snow, want their Chinese counterparts to revalue
the yuan (renminbi)? American officials and a wide range of American
economists argue that the yuan is undervalued vis-à-vis the U.S. dollar
(to which the yuan is pegged at a rate of approximately 8.28 yuan per
dollar). The basis for their argument that the renminbi (RMB) is
undervalued is the very large trade surplus that China has with the United
States and the concomitant buildup of dollar based asset reserves of
China's central bank, the People's Bank of China (PBOC), and other
financial institutions. China has accumulated about $350 billion in
foreign-currency reserves and over $122 billion in U.S. government
bonds. In other words, China is using its trade imbalance with the United
States to become one of the biggest creditors to the
U.S. government (although this is only possible because the U.S.
government is currently suffering from a form of ADD -- American Deficit
Disorder). This mutual dependence creates unique financial risks for the
United States and provides the Chinese government
with a significant amount of leverage over the U.S. government.
And there's the rub. This is why the trade imbalance is a
problem. Indeed, Japan and Germany have had a similar relationship with
the United States, using a trade imbalance as the basis for accumulating
U.S. government bonds and then using their bond holdings as a lever to
"encourage" the U.S. government to take policy stands that were more to
their liking. Japan's central bank still holds more U.S. government bonds
than any other non-U.S. institution and the total value of Japanese
institutional holdings of U.S. government bonds are more than three and a
half times those of China, indicating a much longer-term drain of dollars
from the U.S. to Japan than anything yet experienced between the U.S. and
China. If for some reason the Japanese central bank decided it didn't
want U.S. government bonds anymore and dumped its holdings onto the market
the impact on bond prices (and interest rates) would be quick and
devastating to the U.S. economy. There's no reason to assume that
Japanese officials would do such a thing. After all, Japan is still an
ally of the United States. China, on the other hand, is not. Indeed,
China is perceived in Washington, D.C. as the only real potential rival to
U.S. global hegemony.
This being the case, it is not difficult to understand why it might be of
concern to policy makers in the United States that China is becoming such
a huge creditor nation. But there are other reasons for U.S. government
officials, especially Fed Chair Greenspan and Treasury Secretary Snow, to
complain about Chinese government economic policies. The U.S. economy
continues to grow at a sluggish pace, at best, and jobs continue to
disappear. Indeed, it is only because a recession is defined by output
declines, rather than employment declines, that the U.S. economy is
officially in recovery. It certainly does not feel like much of a
recovery to most "blue collar" workers. When was the last time an
American political leader, whether elected or appointed, stood up and
said, "The economy is in the dumps because I screwed up. It's my fault
that millions are out of work." That's not the prescription for a long
political career. It is much better for one's career to divert attention
to other evils that are behind the economic woes. It was not that long
ago that the primary target of official scapegoating was Japan. It was
the Japanese who were taking good American jobs. And even more recently
it was the Mexicans. But now there's a much better target. China. The
Chinese are not playing fair. They are taking good American jobs by
keeping their currency too cheap. Never mind that current economic ills
can be traced to decisions made by U.S. state officials, in particular the
Federal Reserve Open Market Committee, headed by Alan Greenspan, when they
decided in the waning weeks of the Clinton presidency to trigger a
recession by raising interest rates. It took a lot to slow down the
Clinton economic boom, too much perhaps. The Fed raised rates far too
aggressively and when the economic slowdown finally came it proved far
more resistant to reversal than might have been anticipated by Fed
officials who had come to believe all the rhetoric about what fantastic
economic planners they were. After repeatedly lowering interest rates and
jawboning the Fed has done little more than stimulate a housing boom (and
growing speculative bubble in housing prices).
The fact that U.S. policy makers might want to find a scapegoat does not,
however, mean that Chinese government policies have no role to play in the
current economic environment in the U.S. But is it the negative role that
these policy makers indicate it to be? The argument is that a cheap yuan
results in lower unit costs for Chinese manufacturers (including American
and European transnationals manufacturing in China), which allows for low
price exports to the U.S. These low priced exports displace higher priced
American goods, inventories buildup at U.S. factories, and the result is
layoffs or, even worse, plant closings. Thus, it is argued that Chinese
officials are responsible for the job losses in the U.S. There are two
very obvious problems with this argument. One of the problems was made
clear by Greenspan himself, although perhaps he was not aware of the
contradiction. He pointed out the increasing importance of the
information economy to future economic growth. To the extent the
U.S. economy has already shifted from manufacturing to information
technology, cheap imports of shirts, toys, and other labor-intensive,
low-tech goods from China do not pose a serious threat to future
U.S. growth. If the problem is insufficient demand for existing
information technology, then this problem was exacerbated by the Fed's
successful attempts to slow the U.S. economy and the related bursting of
the speculative bubbles in information technology and
telecommunications. Second, and perhaps even more importantly, the
Chinese government policy of buying heavily in the U.S. debt market has
contributed to much lower interest rates than would otherwise
prevail. These low interest rates have been instrumental in keeping the
U.S. economy from falling further and faster, including stimulating the
aforementioned boom in housing.
In other words, public policies formulated in Beijing have actually been
beneficial to the U.S. economy. Furthermore, cheap Chinese-made exports
into the U.S. economy, the source of the ire of U.S. government officials
and politicians, have benefited American consumers. The effect of lower
priced consumer goods is to increase the real income of these
consumers. They can buy more, live better, than without these low cost
imported goods. The money saved on goods made in China may, in fact,
result in higher purchases of the more capital (and knowledge) intensive
goods manufactured in the United States, not to mention stimulating more
spending on services and other goods that generate jobs in the domestic
economy. It is, therefore, not quite so clear that an undervalued yuan
(if, indeed, it is undervalued) is a zero sum game.
Is the yuan undervalued? This is also not as straightforward as it might
seem. Yes, China is running a trade surplus with the United States
because of the demand for low priced Chinese-made goods. However, the low
cost of Chinese goods is not simply a result of the value of RMB. Low
unit costs are the result of relatively low dollar cost labor in
China. It is quite likely that wages in China are higher, not lower, in
dollar terms than would be the case with significantly less government
(bureaucratic) intervention. On the one hand, if the Chinese government
dramatically expanded the trading band for RMB, such that a lot fewer yuan
could be used to buy a U.S. dollar, then this would place upward pressure
on the average dollar wage in China. However, the Chinese government
could also stop artificially propping up yuan wages by using bureaucratic
mechanisms, including keeping a lot more people employed than are needed
in state-owned enterprises and within the government bureaucracy, with the
result being a sharp fall in yuan wages. The rise in the dollar value of
the yuan might be more than compensated for by a fall in the yuan wage
resulting in a lower dollar wage for Chinese workers and even lower unit
costs than currently prevail. It would still be cheaper for Americans to
buy Chinese goods.
However, it is likely that any shift in government policy that allowed a
much higher rate of unemployment and lower wages would seriously damage
the domestic Chinese economy, create political instability, and halt the
growth machine. A sharp slowdown in the Chinese economy, coupled with
increased political instability, would likely cause the yuan to depreciate
within the new trading range. It is interesting that those who argue for
a free floating yuan (let the market determine the exchange rate) usually
argue for less Chinese government involvement in other aspects of their
economy, including the labor market. A worse case scenario would be to
float
the RMB while simultaneously eliminating the institutional impediments
to more sharply rising unemployment. A repeat of the 1997-1998 Asian
economic crisis would be, under that scenario, an optimistic outcome.
At the end of the day, Chinese authorities will probably do the right
thing and drag their feet on the question of revaluation, much less the
issue of a free floating exchange rate. They recognize that their actions
during the Asian economic crisis, keeping the peg, gained them a great
deal of credibility and have been beneficial to China's economic growth
and development. This is not something that the leaders in Beijing are likely
to give up easily or any time soon.
The irony of all this debate about revaluing the RMB is that it has
probably added impetus to American and European investors and
transnationals to speedup their involvement in the Chinese economy. Both
portfolio investors and firms engaged in direct investment in the Chinese
economy would have a positive incentive to shift more resources into China
while the yuan is relatively cheap, if they expect a higher dollar cost to
such investments in the future. Thus, it may actually benefit the Chinese
economy to have such expectations raised. At least this is the case as
long as those expectations are not met.
Previous Essay
First Essay
Copyright © 2003 Satya J. Gabriel, Mount Holyoke College. All
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