Highlights
– Obama administration thinks Beijing manipulating currency
– As exports from China fall, unemployment will rise dramatically, particularly in rural areas
– Protectionist measures would have deleterious effect on China, the US and World
On January 23, 2009, President Obama’s choice for Treasury Secretary, Timothy Geithner, told the Senate Finance Committee that the new administration thinks Beijing is “manipulating” its currency, and it will act “aggressively” using “all diplomatic avenues” to change China’s currency practices.
The manner in which China has allegedly controlled its currency has been a point of contention between Beijing and Washington for years, with some economists suggesting that the yuan has been kept artificially low to make Chinese exports more attractive. As it stands, many United States (US) manufacturers, unions and lawmakers charge that Beijing tinkers with its currency to give Chinese companies an edge over foreign competitors.
Should the steadily escalating rhetoric between Beijing and Washington continue, the likelihood that both countries may institute protectionist policies increases significantly. If protectionism become the policy prescription both follow, the effects of the global economic downturn are likely to worsen rapidly.
China’s Currency Strategy Will Not Prevent Economic Downturn
Most economists agree that China is doing everything in its power to export as many Chinese-produced products as is feasible, the effect of which is to keep unemployment at bay. The move is not unexpected, particularly as the country’s gross domestic product fell sharply in 2008 and is likely to fall further in 2009. Without a strong export-driven economy, China’s growth, employment and social stability are likely to be severely shaken in the coming months.
However, the problem that remains is whether cheaper goods from China will really increase demand. With consumer spending down across the globe, even drastically lowered prices are failing to attract buyers.
China’s economic ministers likely recognize that global demand, particularly in the US, for Chinese goods is diminishing rapidly. As such, we expect a renewed Chinese focus on attempting to increase the purchasing power of its own domestic economy. However, the 750 million-strong rural population is largely unprepared to replace US purchasers of Chinese goods in the near-term. As such, we do not expect China’s currency strategy to cushion the effects of the economic downturn until US purchasing power raises significantly.
Beijing Responds to Currency Accusations
In response to recent accusations over the strength of its currency, Agence France-Presse reported that China, in a faxed comment, said that “the Chinese government has never used so-called currency manipulation to gain benefits in its international trade.” The report further stated that “unsubstantiated criticism” could lead to a protectionist backlash in the US.
China for a long time pegged the yuan to the dollar, despite objections from some that the practice was keeping the yuan undervalued – boosting China’s trade advantage because goods could be sold more cheaply to other countries.
However, in July 2005, China modified the practice slightly, allowing the yuan to float against a basket of currencies – the effect has been to devalue the dollar roughly 15 percent since that time. Going from US$8 per yuan to around US$6.5 per yuan, Chinese exports have shown a moderate increase in price as a result.
Outlook
America is an enormously important market for China’s factories, which have already suffered dramatically from the economic downturn in the US. The flow of goods from Asia to America has enabled China to build up enormous reserves of Treasury notes, effectively making Beijing the largest creditor of the US in terms of government debt.
Should China respond to the accusation of manipulation espoused by many administration officials and members of Congress by selling off some of those debt instruments, the move would exert tremendous downward pressure on the value of long-term US treasuries.
Further, if Congress does move to enact legislation to address China’s alleged currency manipulation, protectionist policies are certain to follow by Beijing. The result will likely be a significant extension of the current economic crisis that will have a ripple effect throughout the global economy.
