China’s Currency Reforms
China’s decision to end its currency’s two-year-old peg to the U.S. dollar is raising expectation of a gradual appreciation in the yuan’s value — an increase that could bring relief to U.S. and other non-Chinese manufacturers struggling to compete with cheap Chinese products.
Beijing has long refused to allow the yuan, also known as the renminbi, to float and has rejected accusations that its currency is unfairly undervalued. The debate became emotive during the last global recession, when manufacturers from Africa, Europe, Latin America and the U.S. were struck by China’s ability to keep the prices of its exports low.
China, the world’s largest exporter of merchandise, finally agreed in June to float the yuan, just in time for the summit of the Group of 20 leading economies, where President Hu Jintao would have come under criticism. The People’s Bank of China promised to rely more on a basket of currencies that includes the dollar to determine the exchange rate, rather than the dollar alone.
However, the currency reforms would be gradual and the changes would only allow the yuan to fluctuate within a moderately narrow range of 6 and 8 yuan to $1. China had kept the yuan stable at about 6.83 per dollar since July 2008. China likely does not want to cause problems at home by letting the yuan appreciate too much. Doing so would risk hurting its own once-massive export-based industries, endangering the paychecks of workers who make those sectors grow.
Beijing’s decision helps to neuter the potential for future trade friction between China and other countries, especially the United States, which have accused Beijing of manipulating its currency to gain an unfair advantage in international trade. The American Iron and Steel Institute and the U.S. Congress have been especially critical of China’s currency policy. Relations with Beijing’s critics are now thawing. The U.S. Treasury Department, in its July report to Congress on international economic and exchange rate policies, did not declare China a currency manipulator, but merely reiterated its view that the renminbi is undervalued.
Secondly, China’s currency reform will help it to fight inflation and bring its economy back to a sustainable growth path. China would focus on its domestic growth, which will help accelerate imports. This is already happening. China’s second-quarter gross domestic product grew just 10.3 percent over the same period a year earlier, slowing from the explosive 11.9 percent annual growth recorded in the first quarter. At the same time, inflation fell to 2.9 percent from 3.1 percent.
The reform is also meant to aid restructuring of China’s economy. Beijing’s current policy is focused on seeking a balance between accelerating growth and shifting the economy toward a domestic consumption rather than export-led model. In other words, China wants to focus on its domestic growth.
Chinese officials recognize that inflexibility may trigger a financial crisis. They say the new policy will help deliver more resources to the service sector and promote upgrading of industries. A more flexible exchange rate will “reduce China’s trade imbalance and excessive reliance on exports, and help sustain economic growth by relying more on domestic demand.” That would leave more room in the global market for other exports from other countries.
For their part, U.S. officials have always complained that the undervalued yuan represents unfair competition, destroying U.S. jobs as American manufacturing succumb to China’s manufacturing juggernaut and contributing to a skyrocketing U.S. trade deficit. The United States absorbs Chinese exports and pays China in dollars.
Beijing, meanwhile, holds its dollars, amassing $2.5 trillion in foreign reserves, much of it held in U.S. Treasury securities. To some observers, this represents a fundamental shift in the global balance of power because China could bring the United States to its knees by threatening to sell its dollars, sending the value of the dollar into a tailspin.
Still, the currency reform is seen as positive for exporters of commodities to Chinese markets. A stronger yuan will make Chinese-made goods more expensive to foreign buyers. It would, for example, discourage Chinese steel exports and help U.S. steelmakers. In the month since China announced its currency reforms, steel stocks in the U.S. have risen 15 percent.