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Cover Story
Print Edition> Cover Story
UPDATED: April 6, 2010 NO. 14 APRIL 8, 2010
The Crux of the Currency Dispute
China may not be the currency manipulator the United States makes it out to be



The worst financial disaster since World War II has certainly taken its toll globally, but even with recovery in full swing the catastrophe has not been totally alleviated as economic worries still abound. Claims that the recession has gone or the world has entered a "post-crisis era" are premature. But while many countries around the world reflect on what has been and should be done to facilitate recovery, the United States seems bent on hindering those efforts by instigating a trade and currency war with China, accusing China of being a "currency manipulator." This move is obviously unfair and irrational.

Who's the manipulator?


CAR RUSH: Buick sedans produced by Shanghai General Motors move down an assembly line. Car manufacturers have shifted into high gear to fill the insatiable Chinese market (ZHAO YUN) 

Even though China has become a major trading power and has changed the world economic pattern to a certain extent, it is still incapable of taking currency manipulation, considering the country's limited economic strength—its GDP is only one third of the United States'—and overall ability for such an action.

China accounts for 10 percent of the international trade volume, but most of its exported products have low added value. Its currency—the yuan—is not an international currency and cannot perform the function of a medium of exchange. Some label China as the "world factory," but the country should really be regarded as an "employee of the world." America's accusation that China is a "currency manipulator" is analogous to saying the employee manipulates the boss' money. As a matter of fact, the Chinese Government neither has the objective conditions to "manipulate" currencies, nor does it have any intention of doing so.

Every year, the U.S. Government issues a list of what it refers to as "currency manipulators" according to its own standards. The list has in effect placed U.S. domestic law over international laws and regulations. Speaking of "currency manipulation," no other country is in a greater position than the United States.

First of all, the U.S. Government has carried out a deficit financing pattern, which burdens the country with huge debts. The United States needs a large-scale and stable bond market with low interest rates to make up for the deficit and maintain government operations—since the interest rate of U.S. government bonds and its dollar exchange rate are closely related.

If the U.S. dollar is to maintain its status as a dominant currency in the world, it should perform the function of a world currency. The additional issuance of the dollar is exported to other countries through trade deficits. The United States is the world's biggest trader, but, more importantly, it holds the biggest trade deficit, making it the debtor of many countries. The simplest way to make up for the huge deficits is to start printing more greenbacks, but the U.S. Government dares not, as it might trigger a collapse of the U.S. economy due to the over issuance. Therefore, the U.S. Government must rely on other securities and economic leverage, like interest rates and exchange rates, to stabilize its currency.

The United States is the biggest capital exporting country, featured by dollar loans and investments, thus interest is an important source of revenue for its government. In order to guarantee the value of its exported capital, it must smartly leverage interest and currency rates.

Why stabilize the yuan?

China adopted a stable and step-by-step strategy in reforming its exchange rate system and has made remarkable achievements. Years of practice prove exchange rate reform should be achieved in a stable way, which not only helps realize the sustainable development of the Chinese economy, but also benefits the world economy at large. In the meantime, the stable yuan exchange rate system prevents sharp fluctuations and economic disorder from happening in the market.

In the past three decades, the exchange rate reforms among different countries can be divided into two categories. The first opens the capital market completely with no strings attached. It allows a free exchange of currency under both the capital account and the current account, eliminating government control over the exchange rate, and allowing the rate to be pegged to the U.S. dollar and to fluctuate in line with market demand. It allows free circulation and transaction of foreign currencies, removing the state-owned commercial banks' privilege in dealing foreign currencies, opening the financial industry to private and foreign capital, and privatizing commercial banks.

The other kind of approach is to take gradual steps to appreciate or depreciate the currency based on the domestic economic development and marketization progress. The government should first create necessary conditions to reform the exchange rate, strengthen economic power, and open the capital market in an orderly manner. The government will gradually loosen control over foreign exchange rates.

Clearly, China has taken the latter approach. After China allowed its currency to float within a controlled range in 2005, the exchange rate formation mechanism has been undergoing a gradual change accompanied by appreciation of the yuan against the U.S. dollar. Since 2005, the value of Chinese yuan has risen 21 percent.

At present, the value of the yuan is faced with two major challenges. In the international market, it undergoes pressures of appreciation due to U.S. allegations. But domestically, the yuan is at risk of depreciating. The reasons are as follows.

First, China currently forbids a free exchange of foreign currencies in the country. Both the foreign exchange income of exporting companies and the foreign investment in foreign currencies must be sold to the government. The government will pay for those foreign currencies with the yuan. To date, the government has accumulated over $2.4 trillion worth of foreign currencies, which means it has issued an additional 15 trillion yuan accordingly.

Second, under the moderately loose monetary policy in recent years, skyrocketing loans—as much as 9.6 trillion yuan ($1.4 trillion) poured into the domestic market last year—have been unprecedented and placed enormous pressure on the market.

Third, tremendous bank deposits have formed a potentially huge purchasing power, but convincing people and companies to spend this money presents a challenge, despite excess productivity.

Theoretically, the yuan appreciation could help relieve domestic inflation pressures. But it is nearly impossible to appreciate the yuan in the international market, while keeping the yuan stable in the domestic market. Once a wave of vicious inflation sweeps the domestic market, the yuan will be dumped, which would in turn cut the yuan's value.

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