The US-China Trade and Currency dispute: A red herring?

June 8, 2010

By Ramaa Vasudevan, Sanhati

The threat of a full-fledged trade war between US and China no longer seems so imminent. The battle over the China’s exchange appears to have been averted. The biannual report on exchange rate which was to be released on April 15th has been strategically postponed once Hu Jintao, the Chinese President, announced his particpation at the April nuclear summit. There has been a mounting pressure to name China as a currency manipulator in this report, and unleash a battery of trade sanctions. The US has stopped ratcheting up the pressure and China has sent out cautious signals that suggested that the peg was just a temporary special measure and it was considering letting the remnibi float up. Ruffled feathers seem to have been smoothed and the strategic summit currently underway, is not raising any diplomatic dust. The euro woes might postpone the loosening of the remnibi peg, but for the time being a truce has been declared.

So what was the storm all about?

Currency and Trade Wars

China first pegged to the dollar in 1994 in a drastic step that involved a steep devaluation and prompted the label of a currency manipulation. The peg was in fact a crawling peg that allowed the remnibi to float upwards by a small amount. In wake of the 1997 Asian crisis when neighboring countries were being hit by attacks on their currency and were unable to maintain their pegs China held ground, tightening the range of movement of the remnibi. The strong peg was a factor of critical importance in the resurgence of the region. China’s action was in fact welcomed by the US in that it helped limit the contagion effect of the Asian crisis and pre-empt further debilitating rounds of devaluations.

With the recession following the bust of the dot-com bubble, there were growing rumblings in US about currency manipulation by China. As the US deficit continued to surge, Chinese currency interventions (not unlike Japan in the eighties) emerged as a convenient target as US deficits with China have surpassed that with the Japan since 2000. Finally in 2005 the Chinese Central Bank loosened the peg letting the remnibi revalue about 2% in a day. Between 2005 and 2008 the remnibi appreciated by about 20%.

In 2008 as the impact of the subprime crisis spiraled out into a global crisis, the Chinese Government hardened the peg keeping it firm at 6.8 remnibi to the dollar, in order to stave off the spillover from the unwinding of the financial markets. Despite the initial impact of slowdown in trade with the Great Recession, this policy and an aggressive stimulus policy has seen China weather the storm and emerge in 2010 with a projected growth rate of 9% and an IMF forecast for 2011 of nearly 10%. Accumulating about $ 400 billion in reserves in 2009 the reserve holdings of China grew to $2.4 trillion in January 2010. Reserve holdings have grown from 1% GDP in 200 to about 12% of GDP at the beginning of 2010[1]. Now with the US unemployment rate reaching 10%, US policy makers have turned once again to the Chinese exchange rate as the source (or scapegoat) for their domestic woes! US Congress has been pushing the Government to take a strong stand on China’s exchange rate.

By persistently undervaluing their currency the argument goes, China has wiped out its competitors and promoted the deindustrialization of the US as manufacturing jobs in particular were outsourced. China has been charged with a predatory mercantilist policy that is reducing US employment by 1.4 million jobs. So much so that the mandatory lessons about the virtues of free trade do not apply and a protectionist backlash against China has been urged.[2]

The Chinese Premier Wen Jibao on the other hand has complained that the US pressure to revalue the remnibi amounts to protectionism and expressed concern about the safety of China’s dollar investments and the lack of stability of the dollar[3]! More amusing, Wen Jibao a Chinese Communist Party leader also exhorted US multinationals to lobby the US government against resorting to a protectionist backlash[4]!

The question of whether and to what extent the remnibi is undervalued has no precise clear-cut answer and estimates vary[5]. Whatever the validity of these estimates does the charge of currency manipulation stand up to scrutiny? When the US along with the other G7 countries negotiated the Plaza accord in 1985 to orchestrate an orderly depreciation of the dollar, and then two years later another accord to prevent a freefall was this manipulation? A host of government and private sector actions can affect the exchange rate and when a developing country (even an emerging force like China) pursues domestic policy imperatives it can have an impact on the exchange rate. Fiscal profligacy or a downgrade in credit ratings for instance invites speculative attacks that weaken the currency as many developing countries discovered through the eighties and nineties.

More important, how significant an impact will a revaluation of the remnibi have on the pattern of trade? Many factors influence trade balance apart from the exchange rate.

The persistent growth of US deficits through 2005-8 when the remninbi appreciated slightly, and the recent emergence of a Chinese trade deficit in March (of $7.2 billion), seems to suggest that exchange rate adjustment would by itself not be enough to ensure a reduction in the US deficit. The US would merely spread the net in the search for cheap consumer goods imports. The US deficit is not a pure bilateral deficit with China. China accounts for about 39% of the US deficit so a bilateral fix in the form of revaluation would amount to “rearranging deckchairs on the Titanic”[6]. Oil imports in particular would continue to account for a sizable US deficit. Appreciation of the remnibi it is argued would also further erode consumption in China as employment in the labor-intensive export industries slows down and farmers face increased competition from the subsidized US farms.[7] In any case the appreciation of the remnibi would not address the roots of the global imbalance.

Beyond Exchange Rates

The problem of growing global imbalances has haunted international policy debates for much of past decade. The problem stems from the contradictions of an international monetary system that depends on the dollar for generating liquidity. In order to keep the global economy awash in dollars the US needs to sustain a balance of payments deficit. It plays the role of the banker to world by borrowing “short” in the form of international holdings of dollar and US treasury reserves and lending “long” in the form of diverse physical and financial asset holdings. The privileged role of the dollar gives the US an extremely flexible credit line that allows it to run up deficits simply by issuing dollar debt. For this to work the US needs buyers for its treasury bonds. Which is where the Chinese central bank steps in.

China’s integration into the global economy has involved an export led development strategy based not simply on an undervalued exchange rate but more importantly on low wage labor – a race to the bottom. The strategy while yielding a rich dividend in terms of GDP growth and trade surpluses forces China to intervene to keep its exchange rate stable. Since the world wants to hold dollars and is not interested in holding remnibi, China is further constrained by the imperative to lend in dollars. So China ends up buy up treasury bills and in effect helping US finance its deficit. China sterilizes the inflationary impact of buying these bonds by issuing domestic bonds (at a low interest rate) to mop up the spate in liquidity. China is currently the largest creditor of the US government ( the largest holder of US government debt) and is sitting on a mountain of US treasury bills. A collapse of the dollar would wipe out its asset base. The US and China are locked in an uneasy embrace.

This balance of financial terror that has entwined the economies of USA and China – the rise of “Chimerica”[8] reflects on hand China’s export dependence and its high savings. The high savings rates in China and much of Asia) have led US policy makers to embrace the savings glut thesis that points to these excessive savings as the a cause of excess liquidity in the USA. According to this thesis, which American policy makers embrace, Asian investors in search for returns in the wider, deeper and safer markets in the US were thus responsible for the rising US deficits[9]. As Asian countries reeling from the aftermath of the Asian crisis began accumulating a war chest of reserves they fostered the cheap money regime in the US that fuelled the housing bubble and the burst of sub-prime lending and exotic securities. Once again the specter of China haunts the American dream!

While China is a convenient scapegoat for the ills plague the US economy, this narrative misses the real point. The deep structural changes that were engineered by the rising dominance of finance since the stagflationary crisis of the seventies – the neoliberal backlash – have promoted rising inequality and stagnant wages in the US[10]. The US has been able to sustain consumption in the face of this growing inequality through the promotion of debt. The outsourcing of manufacture to low wage countries also helped flood the US markets with cheap imported consumer goods. This debt-fuelled consumption binge of the US is the other side of the savings glut. The share of private consumption in China is 36% of GDP compared to 70% of GDP in the US[11]. The roots of the savings glut thus lie in the neoliberal growth model that has been promoted by corporate finance capital and US imperial power.

The integration of developing countries into the circuit of US dominated finance capital has established a global division of labor where the manufacture of labor intensive consumer goods has increasingly been outsourced to developing countries especially in Asia. This pattern exacerbated the trade deficit of the US. The privileged role of the dollar as an international key currency allowed the US to continue to borrow from the rest of the world- OPEC countries, Japan, and in past decade China. At the same time developing countries that had been forced to launch the neoliberal reform process and liberalize their financial markets bore the brunt of the growing fragility of the system and were beset by a spate of crisis. They performed a safety valve role in a global economy dominated by finance and hinged on the international role of the dollar.

The ability to borrow from China was thus an important part of the mechanisms that helped perpetuate the empire of finance. A key shift that happened after the Asian crisis in 1997, as developing countries in Asia and Latin America in particular began accumulating reserves as a cushion against speculative capital flight, was that the safety valve mechanism in sense broke down. Finance, in its search for profit opportunities, then turned to the least credit worthy and poorest borrowers in the US itself. The collapse of the subprime markets in the US is in this sense an outcome of the same mechanisms that precipitated the Tequila crisis and the Asian crisis in the nineties. The increasing fragility engendered by the process of unfettered financialization has finally come home to financial center – the US markets. These mechanisms are not rooted in excessive saving in China but in the dominance of finance and the imperatives of maintaining the dollar’s international role.

For the time being as was made evident after the collapse of Lehman when global investors rushed to the safety of US treasury bills, the dollar has no rival as the dominant key currency. While the governor of the People’s Bank of China (PBC), Zhou Xiaochuan,(2009) had in a much publicized speech pointed to the urgent need for moving beyond the dollar standard towards an international reserve currency that is delinked from the debt of a dominant country like the US there are no signs that there is impetus for such an overhaul[12]. What is clear is that the U.S. agenda of refashioning the post-crisis world in a way that preserves dollar hegemony depends critically on China.

The Challenge of China

China with its huge surplus and relatively buoyant economy is increasingly being viewed as an emerging power a challenge to the US. The diplomatic waltzes around the currency issue reflect the awkward balance of the dominant power and an upstart contender. The US has to appear to be coming down hard on China its leading creditor, and China has to appear not be bowing down under pressure. The contremps at the Copenhagen summit, tensions around the arms deal with Taiwan and the subsequent threat of sanctions against Boeing, the imposition of tariffs on tyre imports into the US and the retaliatory investigation into auto and poultry imports by China are all part of this tussle. The fact of the matter is that neither US nor China is ready to rock the boat. After the escalation of tensions there is now a lull. The US having secured China’s acquiesance on backing sanctions on Iran (and possibly on North Korea too) has toned down the rhetoric on the currency issue and is refraining from labeling China as a currency manipulator. Despite the occasional protestations about US protectionism and profligacy the Chinese Government has sent out signals that it will appreciate, though at a time dictated by domestic considerations not US interests. The prompt dispelling of rumors that China was moving out the euro ( like its earlier statements regarding its continued commitment to investing in US treasury bills) suggest that it is invested in the stability of the global financial system. Its actions, specifically its currency interventions, as in past during the Asian crisis, certainly are integral to putting a back-stop to the international domino effect of financial crisis.

Other developments, however need to be taken into account. The concentration on the US China trade ties ignores not only the multilateral nature of the US deficit, but equally the wider trade and investment ties that China has been developing with South east Asia, Africa, Brazil and India ( which accounted in the first ten months of 2009 for 17.5% of China’s trade compared with the US share of 13.5%[13]) . While the US still remains the principal trading partner, the resurgent relations with Asia and other developing countries contrast sharply from the slowdown of trade with US and Europe.

China has begun to play an increasingly assertive role in South East Asia and has displaced the US as the third largest trading partner of the ASEAN bloc. It is promoting the use of remnibi in the region. A Free trade area – China -Asia Free Trade Area (CAFTA) -with the ASEAN countries has come into effect in January. Multilateral swap lines of $120 billion have been set up under the Chiang Mai initiative. This initiative (an alternative regionally anchored rescue and financing mechanism) that was set in motion after the US Treasury and the IMF scuttled the proposal to set up an Asian Monetary Fund in the aftermath of the Asian crisis has further consolidated China’s position in the region. Apart from forging deeper trade ties, China is also establishing stronger financial and investment ties in the region. The Industrial and Commercial Bank of China recently secured a license to operate in Malaysia and has bought a 90 % stake in Indonesia’s Halim bank. Beijing has also been stepping up its claims in the South China Sea through naval exercises, its push for offshore petroleum in these waters. While China’s successful weathering of the global economic crisis has helped regional recovery, there are also emerging tensions – for example in Cambodia over Chinese takeover of land and water resources, in Laos over the proposed facilities for the South East Asian games, over bauxite mining and the tourism project on the disputed Paracel islands in Vietnam[14]. All of which point to a renewal of the geopolitical significance of the region. China is also investing in Africa and securing sources of crucial raw materials and primary goods from the region

As long as China continues to maintain its capital controls and the limited convertibility of the remnibi, China cannot pose a real challenge to the dollar. There are, however, some signs that China is slowly fostering yuan liquidity as a prelude to developing a more international role for the remnibi. The Chinese Central Bank has set up bilateral swap lines, independent of the IMF, amounting to a total of $ 95 billion with Argentina, South Korea, Hong Kong, Indonesia, Belarus and Malaysia, broadening access to the remnibi. It has signed a deal with Brazil to increase the use of local currencies instead of dollars and another with Venezuela offering financial support half of which will be paid in remnibi. A pilot program allowing about 400 firms in Shanghai and four cities in the Guangdong province to settle/ invoice cross border trade in yuan has been announced. The recent move to allow certain entities in Hong-Kong to issue yuan denominated bonds would help buttress the emergence of Hong Kong as a important financial center and a crucial bridge in the path towards an enhanced international role for the remnibi . Shanghai is also being fashioned into an emerging financial center. The cautious launch of stock index futures (a derivative based on equity prices) in mainland China also reflects a process of deepening financial markets.

Another interesting development is the emergence of four public sector Chinese banks in the top four slots in the ranking of financial institutions by the ratio of their share price to book value (The fifth is a Brazilian bank!). In 2000 four of the top five slots were occupied by US banks[15]. At the same time after the fiasco of Chinese state-owned oil company CNOOC’s attempt to acquire Unocal in 2005, China’s U.S. equity portfolio holdings have increased from $4 billion in 2006 to $93 billion in early 2010. Chinese financial investments were avidly sought after by US banks including Citibank and Merrill Lynch for the desperately needed injections of funds as the sub-prime crisis unfolded. In fact in 2009 Chinese acquisitions of U.S. equity stakes surpassed U.S. acquisitions of Chinese equity stakes for the first time[16]. While this does not necessarily suggest an eclipse of US banks global domination by Chinese state owned financial institutions, the growing scale of these banks does point to a growing presence of China. The increase in China’s voting share in the World Banks from 2.7% to 4.4% (The US share remains at 16.4%) is an acknowledgement of this new geopolitical reality.

However the accumulating surpluses in China are stoking the rapid growth in lending and credit creation. The $500 billion stimulus launched by the Chinese state in response to the Great Recession has been routed through loans issued by state owned banks further boosting the surge in credit. Bank loans doubled between 2008 and 2009, when new loans amounted about one third of China’s GDP[17] . This credit bonanza has promoted a massive increase in investment- including investment in infrastructure and heavy industry. In 2009, fixed investment accounted for a whopping 47% of GDP[18]. With nearly half of GDP being channeled into fixed investment the fears of overinvestment are very real. More important this credit binge has fostered a boom in commercial and residential property. As fears of overheating mount the government is taking a host of measures to squeeze credit without raising the interest rate, for instance by raising the reserve requirement ratio of banks. The difficulties that beset this attempt to squeeze credit are evident in the proliferating practice of minjian jedai – companies that are beginning to find it more difficult to get loans from banks they are turning to a high interest rate underground market borrowing from high income households through a broker[19]. Finance is not a genie that goes back easily into the bottle!

What is really at stake?

At the same time a narrative of the rising dragon is marred by the steady flow of stories of appalling labor practices associated with high profile corporations. The news of the suicides by nine workers of Foxconn factory at Shenzen in southern China where trendy electronic gizmos like iPAds and iPhones are manufactured, is the latest breach in the shiny façade of ascendant China[20]. Apart from Apple Foxconn also supplies Sony, Hewlett Packard and Dell. After working long and grinding 12 hour shifts in a highly regimented workplace which is housed in a complex which also has huge dormitory complex where they live these young (largely) migrant workers from inland China earn the equivalent of a mere $75 for a 60 hour week[21]. The suicides provide a glimpse of the brutal underside of China’s integration to the global economy, its rising global presence.

The strike in a Honda transmission factory in Foshan (southern China) has spiraled out to other units leading to a suspension of work in four Honda assembly plants in the region[22]. The strike brings into sharp focus the real issue – the rising inequality that is being created as consequence of China’s export led strategy. The question is not simply about exchange rates but of income distribution and the asymmetry imposed by the dominance of finance and the dollar globally. So inequality in the US becomes fodder for debt fuelled consumption, but in China with its different demographic and the conflicted virtue of having to accumulate its surpluses in dollars, inequality has curbed consumption.

The Honda strike also points to how workers in a single strategic unit (like the Honda transmission factory) can lay bare the vulnerability of the global assembly line that today’s corporations have forged. The stoppage of work in a single unit can have repercussions for the global operations of the corporation. The demands of the Honda workers, from the news reports seem focused on the issue of wages. But on the eve of the anniversary of Tianneman Square massacre it might be a good time to question the model of development that this uneasy embrace of US and China represent.

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[1] N. Fergusson, The end of Chimerica: Amiable divorce or Currency war, Testimony before US House of Representatives committee on Ways and Means, (http://waysandmeans.house.gov/media/pdf/111/10-03-24_Ferguson_Testimony.pdf)

[2] P. Krugman, a Chinese new year, New York Times, Decemebr 31, 2009 (http://www.nytimes.com/2010/01/01/opinion/01krugman.html)

[3] Financial Times Wen hits back on exchange rate, March 15 2010

[4] Financial Times China presses US groups in protectionist dispute, March 17 2010

[5] Yiping Huang, Krugman’s Chinese Remnibi fallacy, Voxeu March 26 2010 (http://www.voxeu.org/index.php?q=node/4801)

[6] S. Roach, Blaming China will not solve America’s problem, FT March 29 2010

[7] Joseph Stiglitz, No time for Trade War, Project Syndicate, April 6 ,2010 (http://www.project-syndicate.org/commentary/stiglitz124/English)

[8] N. Fergusson, Ascent of Money: A financial history of the world, New York 2008

[9] B. Bernake, The Global Savings Glut and the US deficit, Sandridge Lecture, Virginia Association of Economics, Richmond, Virginia (http://www.federalreserve.gov/boarddocs/speeches/2005/200503102/)

[10] See G. Dumenil and D Levy, Capital Resurgent, Harvard University Press, Cambridge, 2004 and A Glyn, Capitalism Unleashed, Oxford University Press, 2006.

[11] Nouriel Roubini, US-China Currency and Trade Collision Course, Roubini Global Economics February, 24, 2010.

[12] Z. Xiaochuan, Reform the International Monetary System, Peoples Bank of China. 2009 (http://www.pbc.gov.cn/english/detail.asp?col=6500&id=178)

[13] J. Kynge Central Plot of US China ties faces off-stage challege, FT January, 8 2010

[14] Financial Times A Wider radius January 27, 2010.

[15] Financial Times China Lenders eclipse US rivals, January 10, 2010

[16] J C de Swann, China goes to Wall Street: China’s evolving US investment strategy, Foreign Affairs April 29

[17] Financial Times , China seeks to ease pace of lending, February 13.

[18] Nouriel Roubini, US-China Currency and Trade Collision Course, Roubini Global Economics February, 24, 2010.

[19] G. Tett, Grey areas in Chinese loans give pause for thought, FT May 21, 2010.

[20] New York Times, Deaths shake a titan in China, May 27 2010.

[21] D. Pilling, The dark side of China’s dream, Financial Times May 27, 2010.

[22] New York Times, Strike in China highlights gap in workers pay, May 29 2010.

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