March 21, 2010

Rating The Yuan

Four years ago, US senator Charles E Schumer made a trip to China to persuade lawmakers there to allow their currency, the Renminbi, popularly known as the Yuan, to fluctuate according to the market. China yielded, and in the next two years, it appreciated fifteen percent against the dollar. That time around, he had warned China of a tariff of 27.5% on Chinese imports until China adjusted the value of its currency.

Fast forward two years. In the height of the financial crisis in July 2008, with the dollar losing value, China again pegged the Yuan to the dollar to prevent its exporters from losing out on conversion. For perspective, China has a 4:1 export import ratio with the US, and singularly contributes to over 40% of its total trade deficit of around $43 billion.

Schumer is now pushing legislation that would designate China as a currency manipulator, with punitive measures to follow. In his words, “They simply want to increase their economic power and we will do whatever it takes to do that. And the only way to change them is by forcing them to change”

But he was just echoing popular sentiment. Nobel Laureate Paul Krugman called for a 25% tax on Chinese imports to America saying “never before in history has a nation followed this drastic a mercantilist policy”. The New York Times, in an editorial this week, called on other countries, such as India and Korea, also affected by China's exhange rate regime, to pressurise the country to let the Yuan to appreciate. This is based on the logic that a weak Yuan making exports of these countries uncompetitive, by allowing Chinese exporters to sell at lower dollar prices as they were getting a higher price out of conversion. (India, on its part, has chosen to remain largely silent on the issue)

But the US is severely affected, or atleast it claims to be. The reasoning is worth paying attention to. America’s trade deficit with China (the excess of its imports over its exports to China, in dollars) stands close to $20 billion. If you apply the appreciation of the currency of another country that has a similar exports to GDP ration, lets say Korea, (the Korean Won has appreciated by 23% in the one year leading upto January 2010 - the period for which we have the latest available trade figures) to the Yuan, it can be said to be undervalued by at least twenty percent. Apply this to the deficit and you’ll find that it could have been lesser by $4 billion (20% of $20 bn), a whopping 10% of America’s total deficit.

But not everyone seems to buy the argument. For example, some bloggers wonder why, in that case, one should not assume that China might also not allow free capital account convertibility. If that were to happen, they argue, the demand for dollars in China from people looking to park some of their assets abroad would actually depreciate the Yuan. James McGregor a senior counselor at Apco Worldwide had yet another point when he spoke to Bloomberg last week saying, “it (the argument) is nicely packaged to solve America's trade deficit problem, but talking decontrol it will only make China reluctant to make a change”.

And that leaves us with yet another argument. Would any purpose be served by cajoling China every other day? With its lately acquired status as an economic powerhouse that weathered the financial crisis, China is in no mood to bow, or atleast be seen as bowing, to international pressure. And here’s the catch. With commodity prices soaring, the country may be able to provide respite to importers by making the Yuan more valuable. So it might actually be in China's interest to appreciate the Yuan now.

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