US domestic politics often cloud the yuan exchange rate issue instead of making way for mutual economic benefits
Although China and the United States have agreed on a stable yuan, we should notice that since July 2005, the yuan has appreciated by up to 21 percent. But this has not significantly improved the United States' trade deficit nor reduced China's trade surplus. The driving forces of today's exchange rate have gone far beyond bilateral trade. To understand what is happening, an analysis of the open global production and trading system is necessary. It is unlikely that greater yuan appreciation, as demanded by some US Congress representatives, can alter China's status as the "workshop of the world" and substantially boost US exports.
While the US could experience limited economic gains if any form of sanction is enacted, the Chinese economy will suffer serious damage. First, a surcharge tariff of 20 percent or more will drive a large proportion of Chinese exports out of the US markets and will significantly reduce external demands. Second, many workers in coastal export processing zones will lose their jobs, resulting in a slowdown of economic growth and social unrest. Third, as more speculative capital enters China with a bet on yuan appreciation, the problem of an asset bubble in the Chinese economy will worsen and could spiral out of control.
A Chinese-US trade and currency war will threaten the entire East Asian economy. Goods marked as "Made in China" have actually involved a collective division of labor across the region. In the past 15 years, East Asian economies including Japan, South Korea and Singapore have moved their assembly lines to the Chinese mainland to take advantage of its cheap labor costs and they continue to target their exports at the US market. As a result, these economies have greatly reduced their trade surplus with the US, while China is perceived as having the largest trade surplus. A trade and currency war between the US and Asia will therefore trigger significant knock-on effects for the region.
As China leads the world out of the recession, the Chinese economy has become a great engine of global economic growth. Consequently, a Chinese-US economic war could undermine the faltering recovery of the global economy. For example, panic-induced capital holders could dump dollars and buy euros, resulting in a substantial appreciation of the euro. This is definitely not in Europe's current interests. Among other consequences, it would exacerbate the impact of the Greek debt crisis on the European Union economy.
When US President Barack Obama took office early last year, he sought to strengthen China-US cooperation in the Korean Peninsula, Afghanistan and Iran; on global governance reforms involving institutions and groupings such as the International Monetary Fund and the G20; and on climate change and anti-terrorism policies. Despite quarrels over US arms sales to Taiwan and Obama meeting the Dalai Lama, strategic cooperation between the two countries has remained strong. Faced with continuing global challenges, the US needs China's continued cooperation. If a US unilateral act toward the Chinese currency triggers a trade and currency war, the relationship will be severely damaged.
Why has the US continued to put pressure on the yuan? And how likely is it that this pressure will lead to action? These questions can be answered by an analysis of US domestic politics and the recent diplomatic friction between the two countries.
As the US mid-term election approaches, the weakening political support for the Democratic Party and President Obama is evident. Maintaining a Congress majority will be a difficult challenge for the Democrats. Using China as a scapegoat is always helpful to domestic politics, as it diverts popular dissatisfaction with Obama's economic policies. Taking action on the yuan will please voters who complain about the US high unemployment rate. On the other hand, China's rapid economic rise is a source of public concern. It is good timing to "take on China".
Threatening sanctions on the yuan may be regarded as saving "face" in the recent bilateral diplomatic row over US arms sales to Taiwan and Obama meeting the Dalai Lama. The Chinese government views Taiwan and Tibet as the nation's core interests and publicly condemns these moves. In the US, Chinese actions are now interpreted as "arrogant" or "tough", altering the former "low profile" perception of China. An assumption can therefore be made that Americans want to teach the Chinese that the US is still the largest power in the world.
One lesson we can learn from this exchange rate dispute is that we are faced with an increasingly integrated global economy. The global financial crisis and structurally imbalanced global economy indicate that the macroeconomic authorities of most countries have failed to adapt to this new reality. As a developing country, China has learned from the successful experience of export-led East Asian countries and has pursued a stable exchange rate policy as well as a moderate accumulation of foreign exchange. But five to 10 years ago, few could have predicted such close interdependence between the Chinese and global economies.
We must be extremely prudent about the impact of the global economy in which China, the US, East Asia and other regions are closely linked. We have to handle the yuan exchange rate with rational analysis. The recent consensus between the US and China in finding a sensible way to solve their dispute on the yuan helps avoid tremendous negative consequences to the recovering global economy. In the US, domestic political imperatives can give way to a more rational policy-making process. A rational decision will benefit all economies, including that of the US.
The author is a professor of the School of International Studies at Peking University and Director of the university's Center for International Political Economy.