Recession calls for good currency management

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By Colin Speakman (China Daily)
Updated: 2009-02-04 07:43

The accusation by US Treasury Secretary Tim Geithner that China is engaging in currency manipulation should not have been unexpected given US President Barack Obama's references to this in his election campaign.

Now in office, the 44th US president is keen to show early on that he keeps his campaign promises and restating that currency concern officially goes along with that.

However, it is unlikely to be taken much further than that in the current global climate and, as with a number of other policies, closer examination may well lead to a sensible reassessment.

Economists are quite good at examining data and confirming an analysis, so backing up that "manipulation" accusation with independent economic support is not such a home run.

Aside from the fact that I would prefer we use the word "management", the next question could well be "Yes, and what's wrong with that?" A period of good currency management in this era of huge economic instability could actually be desirable.

Does the world really want a much stronger yuan right now? Let's ask China's biggest trading partner, the European Union (EU). The yuan has risen over 12 percent against euro last year. Hardly currency manipulation to keep yuan "undervalued".

This dramatic change has certainly hurt Chinese exports to a recession-hit Europe, and it has caused major problems for European businesses that have forged links with China and count on affordable supplies to Europe.

As far back as 1979, the European Monetary System was established to manage individual European currencies and keep them from unstable and wild fluctuations.

This system supported expansion of the EU for two decades before the ultimate removal of such risks was enacted - the single currency - euro, introduced in this decade and now adopted by more than half the members.

Now, some will say that China is a long way geographically from being the EU's neighbor, but in economic terms it is not that far. Just in the same way that Germany became a major production supplier to its European neighbors, China has become another manufacturing workshop for Europe.

There is a mutual interdependence requiring long-term stability and currency movements are highly relevant to this. Stable exchange rates, avoidance of unreasonable trade restrictions and strong inter-government relations are important building-blocks. Chinese Premier Wen Jiabao's strategic visit to the EU immediately after Chinese New Year is a testament to this.

So why would the needs be that different in the trade between China and its second biggest trading partner, the United States? Why isn't currency stability of the kind we have seen in the last year between Yuan and US dollar to be applauded after a previous 5 percent appreciation of the yuan?

"It's that huge US trade deficit, stupid!" Oh, but good students of international finance from the past would know that since the time the US became the supplier of the world's reserve currency, it has taken advantage of that to run large current account external deficits with impunity while other countries fretted over not having sufficient foreign exchange reserves (dollars of course) to retain confidence in their currencies. US trade deficits did not start with trade with China.

The balance of payments overall is a "zero sum game" and the world cannot be in deficit as a whole. For every "worrying" deficit, there have to be some "pleasing", or perhaps "equally worrying", surpluses elsewhere.

The US has chosen to live high on the hog, enjoy inexpensive imports from China, and inevitably run a trade deficit as a consequence - in the booming years most Americans did not seem to mind - and China has run the consequential surplus, diverting a significant amount of its domestic output to Western consumers rather than for the benefit of its own.

To fund that US deficit, capital inflows were needed and China has played a big part in that - recycling funds and holding US debt in record quantities.

Now if you were a government holding another country's debt, what exchange rate would you like it to represent in your own currency? Seven yuan for each dollar, or 6 or less? So what exactly would the US be asking China -please keep buying and holding our dollar-denominated debt and also please help us lower the value of the US dollars you are holding?

There's no doubt that in the global recession the value of world trade is declining. Restoring trade needs to be the goal, avoiding policies that restrict trade and appear based solely on self-interest. It would be in China's self-interest right now to have modest depreciation of yuan, but the authorities haven't sought that. The US administration should note that.

It would be good to see President Obama, alongside the policies rushing in change "because we can", reaffirm clearly a commitment to encouraging trade and rejecting policies that can damage trade.

Already we have a US senator saying that to mitigate the impact of US icon Microsoft's thousands of job losses, the jobs lost should be foreign workers'. Next we have included in US economic stimulus packages proposals that funded projects should only contract with US suppliers.

Fortunately, US business groups have already stepped in urging Congress to ensure that the stimulus package does not include trade-restrictive provisions that would undermine the ability of US companies and workers to export goods and services made in the US.

They are to be commended for that wise global overview of the damage that such a short-sighted policy would ultimately bring. I hope President Obama is similarly well-advised about the damage persisting with a short-sighted currency criticism policy might bring.

The author is a director of China Programs at the American Institute for Foreign Study

(China Daily 02/04/2009 page4)