Wednesday, November 30, 2011

The Conundrum of the Chinese Currency

It is becoming an annual ritual of sorts. A year after unequivocally terming China's undervalued currency, the renminbi, as an irritant, and imploring Beijing to adopt a more flexible exchange rate regime, this month, President Obama again urged China to change its monetary policy. Beijing is unlikely to respond favorably. Why should the U.S. be concerned?

It should because the undervalued renminbi is matter of great import to the U.S. economy. The trade between the two countries is immense; China is the second largest trading partner of the U.S. and the U.S. is China’s largest trading partner. In 2010, according to U.S. Foreign Trade statistic compiled by the U.S. Census Bureau, U.S. imports from China were worth a total of a whopping $ 264.2 billion while exports were much less at $63 billion. Hence, an undervalued renminbi means that Chinese consumers have to pay more for U.S. exports than would be the case if their country’s currency was allowed to move freely under a floating exchange rate system. There is consequently lower demand for U.S. exports such as automobiles. This is detrimental for U.S. exporters and for the public, who would benefit from greater employment opportunities made possible by increased exports to China.

More troubling for the U.S., however, is the country’s import bill with China. An undervalued currency, after all, also means that Chinese goods are very attractive for importers and since they are artificially cheap, there is huge demand for them in the U.S. market. Wal-Mart alone does billions of dollars worth of trade with China. While that might be good for Wal-Mart and companies which outsource production to China, that is not necessarily the case for the American people. With unemployment rate of 9.0% in November, Americans need their jobs to stay in the U.S. If China allowed its currency to naturally appreciate, Chinese goods would become dearer to Americans. Consequently domestic counterparts of  imported goods would become more attractive and demand for such goods would rise, leading to higher employment in the U.S.

Due to the high imports with China, the U.S. trade deficit with China is also ballooning. In 2010, according to the US-China Business Council (USCBC), the trade deficit with China was an immense $226.8 billion. Since 2000, that trade deficit has increased from about $100 billion by $ 143.1 billion and it shows no signs of receding. This is troubling because U.S. is spending more than it can pay all the while China is busy buying U.S. bonds. If the country continues to remain indebted to China and trade deficits continue in the direction they are going, serious problems could ensue. The U.S. might even have to face the predicament of counties like Greece, which have paid the price of their profligacy and whose inhabitants are faced with painful budget cuts under austerity programs.

China is essentially subsidizing its exports by constantly intervening in the market by buying currencies of other countries in order to keep its currency undervalued. In a way, the situation is similar to dumping in that although China is not selling its exports below the costs of production per se, in reality that might well be the case if we take into account the real value of the renminbi as opposed its artificially deflated one. What is needed thus is protectionism. The U.S. government should consider imposing tariffs on at least some categories of Chinese imports; these tariffs will generate revenue for the government so tariffs are a better option than quotas but more importantly protectionism will help rein in trade deficits with China and potentially stem the tide of the flight of jobs to Guangzhou and Shanghai.
Could protectionism trigger a “trade war?” Well, that is unlikely because other frustrated trading partners of China have also voiced concern about the renminbi, and China is too dependent on the U.S. for its exports that it can ill afford to exasperate U.S. even more and force it to retaliate in an ever stronger manner. Of course, free trade sans barriers is always more desirable than protectionism, but when one trading partner, as many critics have pointed out, is not playing by the rules then it is almost inevitable that the other partner will have to resort to protectionist measures. The U.S. government thus can and should act to change the status quo of trade with China.