Why China Won’t Move on Currency

Despite American pressure and possible sanctions, China is unlikely to agree to appreciate its currency any time soon.

With American lawmakers calling for punitive tariffs and the Brazilians forecasting a global “currency war” it does seem that there’s a lot of anxiety going about. Is it really all about China’s unwillingness to float its currency and if so, why are the Chinese stalling that process?

The Chinese depegged the renminbi from the United States dollar only in 2005. The value of the Chinese currency has since increased steadily and the People’s Bank of China is allowing it to float in the foreign exchange market albeit within a narrow band. But the Chinese have employed some tricks in order to keep their exchange rate stable.

Since the start of this year, Chinese can exchange no more than $50,000 a year for renminbi, which effectively perpetuates the dollar peg. China has also begun to shift its reserves from dollar accounts into currencies of other trading partners, prompting these nations to invest in dollars to keep their own currencies cheap and exports affordable. As a result the value of the Chinese currency against the dollar is practically unchanged.

Policymakers in Washington want China to appreciate its currency. An undervalued renminbi, they say, is giving China an unfair advantage in global trade because the price of its products is artificially kept low.

American treasury secretary Timothy Geithner last week urged the Chinese to do even more. “For too long many countries oriented their economies toward producing for export,” he said, “rather than consuming at home — counting on the United States to import more of their goods and services than they bought of ours.” From the American perspective, it’s all about “rebalancing” world trade and if that means sanctions, so be it.

The secretary’s observation, that Americans have been buying more from China than visa versa, is quite correct though it misses a crucial point, which is that China has simultaneously been funding America’s national debt. As the current administration continues to spend hundreds of billions of dollars it doesn’t have, that Chinese willingness to borrow has been nothing short of essential.

China and the United States actually want the same thing. Both want to bring balance to world trade and boosting China’s internal demand is the most advantageous way to do that.

Aside from the eastern seaboard, China is still a poor country. Its prime minister, Wen Jiabao, who recently defended China’s monetary policy in Brussels, is an outspoken proponent of extending industrial growth into the hinterland. On the whole, China’s economic development “still lacks balance, coordination and sustainability,” he has said. A sudden increase in the yuan‘s value, as the Americans are calling for, would bring “disaster” to China he believes. “Factories will shut down and society will be in turmoil.”

No matter the country’s impressive growth rates, the Chinese leadership is still very much concerned about the prospect of social upheaval hampering China’s rise and threatening Communist Party rule. Beijing spends about as much on external defense as it does on internal security ($75 billion in 2009) and not without reason. Unrest in the southwestern provinces of Xinjiang and Tibet continues in spite of sometimes violent oppression. Tens of thousands of protests take place across the country each year. Even in the fast growing cities along the coast, public discontent with the lack of political freedom is mounting.

Politicians in the United States are faced with popular unrest as well. With millions of Americans still out of work, it may be tempting to juxtapose American joblessness against China’s success but lawmakers should be honest when complaining of jobs being shipped overseas. It’s not China’s favorable exchange rate nor low wages in East Asia alone that drive businesses and jobs abroad; high tax rates in the United States are also to blame.

The top income and corporate tax rates in America are 35 percent. Singapore, by comparison, which is one of the richest and economically freest countries in the world, maintains a top corporate tax rate of just 18 percent. Even China does better at 25 percent.

Europe is rather caught in the middle of all this. Prime Minister Jean-Claude Juncker of Luxembourg admitted last week, while his Chinese counterpart was visiting Brussels, that the yuan remains undervalued. But he added that an “orderly, significant and broad based appreciation of the renminbi would promote more balanced growth.” French Finance Minister Christine Lagarde told ABC’s This Week on Sunday that the absence of protectionism was what set the latest crisis apart from the Great Depression of the 1930s. Now that the world is recovering, nations shouldn’t resort to things like tariffs and currency manipulation in order to help themselves at the cost of other economies.

Economy Commissioner Olli Rehn meanwhile has been stressing that the euro cannot continue to bear “a disproportionate burden in the adjustment of global exchange rates.” The recovery of the eurozone may be “weakened” he believes, unless everyone works together.

Next month the members of the G20 convene in Seoul, South Korea to discuss the global recovery. The “currency war” as the situation has now been popularly dubbed is likely to dominate the agenda unless a bilateral compromise between China and the United States is reached in the meantime. If not, the rest of the developed world should push for another Plaza Accord which drove down the value of the dollar compared to the Japanese yen in 1985. America and China will both have to compromise.