September 28, 2004

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China at the Big Table

Much has been made of China's invitation to the G8 meeting in Washington this Friday. There has been a massive US focus on fixed exchange rates in general and China's in particular and this will form one of the main talking points at the meeting. Except China won't be in the meeting itself. China's Minister of Finance and PBoC's Governor will only attend the dinner after the main talks. It's a long way to go to have the American's tell you off and to eat rubber chicken. Regardless, China will make the same points it has been repeating on this issue. They will re-iterate their longer term intention to float the currency when conditions are right; that they are working hard to bring about a soft landing to control inflation pressures and create a more sustainable rate of growth; that they are also working hard on getting other macroeconomic settings right; that the financial sector reform in dealing with bad debts and other microeconomic reforms continue apace; and that the time to float the yuan will be once these issues are sufficiently dealt with and not before then.

The US has a very fine line to tread at the meeting, particularly with the election campaign entering its final phase. They need to be seen domestically to continuing to bash pressure China on the issue, despite the consequences. China should be praised for the good nature it takes this pressure. After all, China is one of the largest buyers of US dollars and has prevented the currency going into free fall (along with the Bank of Japan); China is one of the largest buyers of US Treasuries (again along with Japan) and has thus helped keep US interest rates low and helped stimulate the housing refinance boom and keep the US consumption-inspired recovery going; and China is one of the largest trading nations with America and Wal-Mart's largest suppliers. Some thanks.

The reality is even a revaluation of 15-20% in the yuan would do little to dent China's competitive advantages in trade. China (despite some bottlenecks) has a vast amount of labour and is starting to effectively direct capital to take advantage of that. It has far lower living standards and costs of living, enabling it to employ that labour cheaply. What such a revaluation would do is cause untold damage to a fragile and bad-debt laden financial system and drag literally millions just coming out of poverty straight back into destitution. The reality is China's currency peg at the moment is more about controlling domestic pressures, especially inflation, than about being a tool for international trade. Indeed China's terms of trade have turned: in the first four months of this year China actually had a trade deficit of almost US$11 billion. The world economy is improving at the same time as China is trying to engineer a soft landing, and China is dealing with its own rising inflation rate. So the upward pressure on the yuan is easing regardless.

Japan and Europe have long realised that the yuan peg is more important in fighting inflation and keeping China solvent. Hopefully after the election, if not before, America will realise the same.

posted by Simon on 09.28.04 at 11:17 AM in the


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