On February 4th, the Treasury published its 2010 annual “Foreign Exchange Report” to Congress, where, according to the law that mandates it, it must consider “whether countries manipulate the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustment or gaining unfair competitive advantage in international trade.”
The report itself is a light 14-page thing written in an accessible style (even too much so), and I recommend anyone interested in trade and foreign exchange issues to read it, if only to marvel at the Treasury’s neglect of its own mandate (it is not not the first time we point fingers on Timmy; as much as we like him in his Fedman’s side-kick and a quasi-superhero role, we think the world needs him doing his job too)
Basically, the report finds China incurred in the wrath of section 3004 of the omnibus trade and competitiveness act of 1988 (namely, that it manipulated the rate of exchange for purposes of preventing effective balance of payments adjustment or gaining unfair competitive advantage in international trade) using virtually every trick in the bag, like hoarding currency, raising commercial bank reserve requisites and interest rates while at the same time restricting capital inflows, everything. Next, in an unexpected twist that knocks the reader’s breath out of himself, it deems China not guilty of this very same crime. How can this be done? Behold the taming of logic by Tim’s office. The redeeming circumstances are:
- That China promised in June to revalue the yuan and made good its word in the following seven months by a whooping 3,7% (a quick research in the Internet following rigorously frivolous methods proved that estimations of the undervaluation of the yuan range from 10% to 50%, of course if we don’t consider China’s official own estimates, which result in… overvaluation)
- That Mr. Hu promised during his visit to Washington in January 2011 “to promote RMB exchange rate reform and enhance RMB exchange rate flexibility, and promote the transformation of its economic development model” and China has since taken some measures to allow trading in yuan in HK to some degree.
- Most central to the argument of the paper, that inflation will take care of the exchange rate problem if left alone (The report even includes a box with an explanation on how inflation affects real exchange rates in a Sesame-Street style that would embarrass an elementary student. Since the report is meant for Congress, it could reflect on the esteem in which the Treasury holds the knowledge of Congressmen. More worryingly, I suspect the box was meant for the Secretary to understand the paper and that a trainee who was too busy updating his Facebook profile forgot to erase it from the final copy)
Lets not waste too much time commenting on the pathos of the two first arguments. I could give a bunch of vintage links to similar promises and views of people in China like the ones the Treasury says it’s hearing clamouring for appreciation, such as this, this or this, but I won’t (hey, wait a minute!)
Point is, yes there are promises, yes there are voices supporting it in China, but there’s no appreciation. And there’s some degree of abasement in the way resolute action against an aggressor is replaced with hope that he will choose not to hurt us too much.
Even if China did some real progress in allowing offshore yuan trading, countries like Korea have shown how much leverage a country has in managing its exchange rate just with marginal tweaks of the exchange rules (for instance, Korea has kept its won pretty much where it has wanted within a 0 to 30% bellow fair value band for as long as needed just by using a wise blend of prohibition of “naked” or purely speculative forward contracts, limits to foreign currency indebtment by local banks or branches and the threat of intervention) Can you imagine the kind of influence China will be able to exert on its “gradually more flexible” exchange rate while it manages a transition of 100 years?
As for the inflation saviour: the fact that China will get inflation that will partially offset the effect of its aggressive exchange rate policies is beside the point. The Treasury’s job is not to read the leaves, but to assess the situation and let politicians take decisions.
China’s currency repression is a classic mercantilist practice that has been used in all the trade wars to date. How fittingly the article in this link makes a historical connection between militarism and mercantilism. Check especially these articles were James Kostohryz explains superbly the effects of exchange rate devaluation on domestic production abroad:( 1, 2, 3 )and refutes the theories supporting that this practice is benefiting the rest of the world via lower prices.
Inflation is a likely outcome with this kind of policies, but by no means a foregone conclusion. Even more than with the exchange rate in markets of limited convertibility, central planning gives the government a huge leverage in controlling inflation. It will fight tooth and nail before giving in to real appreciation as, as a matter of fact, it is fighting it now. In this respect, all the measures the Chinese government is taking to combat inflation in unconventional ways (wage controls, credit limits, mandatory commercial bank reserves increases, targeted taxes, the whole kitchen sink!…) can also be seen as trade warfare. Will Tim include them in his next report?
Tim, with his Chinese classic education, might think he is “killing with a borrowed knife” (or, as he would put it, “借刀殺人”) but the truth might be less heroic: the inflation that the Treasury predicts for China will have been the effect of an unfair practice sustained for many years and, by the moment it appears, although it will certainly start to offset the effect of artificial devaluation , enormous damage will have been done.
In a manner of speech, the mercantilist monster that devours jobs abroad will have suffered an indigestion due to its gluttony. Whether this will make its lunch feel better is an altogether different matter, but at least Tim seems to be satisfied. That’s the problem with superheroes’ sidekicks: they might not be too bright, but they sure are righteous.