Friday, 16 April 2010

Yuan revaluation: an alternate view

A nation's monetary and exchange rate policy require a multi-dimensional approach. The US Federal Reserve Bank monitors a host of factors to forecast future economic trends and manage policy.
Bernanke's job is a thankless one. Get the mix right and either no one will notice or the politicians hijack all the credit for the good times. Get it wrong and be constantly grilled by various Congressional committees.
Take Alan Greenspan. During his tenure, few Americans complained about Greenspan's low interest rate policy. People were too busy adding stock portfolio gains to their ever increasing house prices, and consuming goods and services with their new found unrealized paper wealth.
Today Greenspan is demonized as a factor in causing the Great Recession.

Like the US, China's economic policy cannot take a simplistic approach. China's economy too has various competing forces at play, both domestic and international.
However, given China's 2.7 trillion US Dollars in exchange reserves China's exchange rate policy is highly politicized. From the US Treasury Secretary's 'surprise' visit to Beijing to Congressional leaders demanding China be labelled a currency manipulator, emotions are running high.
The US Administration seems to be caught in a bind. US domestic politics demands a tough line but realpolitik dictates a softer approach.
China is the largest lender of funds to the US. Every US government Treasury bill China buys is effectively a loan to the US government. And the US is borrowing a heck of a lot of money these days!
Many argue that the situation is caused by Chinese government policies which keep the Yuan's exchange rate artificially weak, thus stimulating US imports from China. After all, the primary source of China's hoard of Dollars is purchases of Chinese goods by the Americans. Further, it is suggested that all of America's trade problems with China will be resolved as soon as China allows its currency to strengthen against the USD.
History suggests there is more to trade relations than merely currency values.
In 1985, the US had a 46 billion Dollars trade deficit with Japan. The USD – Yen exchange rate was 254.78 Yen to one Dollar. In 1995, the trade deficit increased to 59 billion Dollars although the Dollar had lost more than half its value. In 1995, one Dollar could be purchased at approximately 99 Yen. In 2009, the trade deficit had reduced to 45 billion Dollars while one Dollar purchased approximately 90 Yen.

Essentially, the US had 'inflated away' its debt obligations to the Japanese. The Japanese, as one of the largest creditors of the US, were being repaid with a debased US currency; a currency worth approximately one third of its 1985 value.
Is the US pushing the Chinese to revalue the Yuan for similar reasons -borrow today's Dollars from the Chinese and repay them with a weaker Dollar sometime in the future?
A stronger Yuan has other repercussions. US children will pay more for Barbie dolls, imported from China. We all know that the US dependency on imports of Chinese manufacturing products extends well beyond Barbie dolls.
Politically, a strengthened Chinese currency may increase Sino-US tensions. Chinese purchases of overseas assets will increase from their already heightened pace. Whether China is purchasing mining assets in Africa or bidding for US oil companies, the price tag for China will be lower due to a stronger Yuan.
During the last decade, 9/11 is not the only momentous event to have occurred. China's entry onto the global stage has been gradual but becoming ever more apparent.
When pushing for a stronger Chinese currency, the US must beware of the 'Law of Unintended Consequences.' We must be careful what we wish for just in case we get our wish.

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