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Dichotomy of a revalued renminbi

By Zou Hanru (China Daily)
Updated: 2006-07-28 10:03

Something unprecedented happened last week. But with the world's attention focused on the Middle East crisis, it passed off almost unnoticed.

On July 21, the renminbi (or yuan) traded at 7.9845 to the US dollar, its highest level since last year's revaluation. The new rate beat the previous post-revaluation high of 7.9850 yuan a fortnight ago.

Last year, as part of its commitments to the World Trade Organization (WTO), China changed its decade-long currency peg, which had been fixed at 8.28 to the US dollar.

On July 21 last year, freed from its peg to the greenback and tagged to a basket of currencies, the yuan appreciated by 2.1 per cent to 8.11 to the US dollar.

But some US politicians continue to claim that the yuan is undervalued, allowing China to keep its export prices artificially low. Their main concern seems to be Chinese exports, which have been rising as a result of demand from US consumers and importers.

What they deliberately ignore is that, despite their technical and industrial superiority, US entrepreneurs have been unable to compete with their Chinese counterparts. Their contention is that "cheap" Chinese products threaten jobs in US industrial heartlands.

China has been doing all it can to maintain a balance in global trade, which is supposed to be governed by WTO norms.

The United States, however, seems to have a skewed view of free trade. When it comes to its own exports, it readily falls back on the WTO. But Washington pretends the WTO doesn't exist when it comes to exports from China or other developing countries, never mind its own farm subsidies. And that is precisely why the Doha round of world trade talks were suspended in Geneva on Monday.

China has appreciated its currency further, to 1.57 per cent, against the US dollar since July 2005. The latest appreciation came after the People's Bank of China fixed a mid-point exchange rate of 7.9897 against the dollar, stronger than 7.9918, the rate at which the yuan traded a day before its historic high of 7.9845 on July 21.

The central bank's move came as part of the central government's measures to rein in a runaway economy that grew 11.3 per cent in the second quarter of this year. But despite that, due to its focus on exports, the Chinese economy is still expected to grow by 10 per cent in 2006.

The United States has tried every trick in the book to stall Chinese exports. It pushed for restrictions on Chinese textile exports and had them imposed last year. That, however, has not stopped US manufacturers from alleging that the "undervalued" yuan continues to give Chinese exporters an alleged unfair advantage. They claim China's huge trade surplus of more than US$200 billion is partly a result of that, and demand that the yuan be appreciated by as much as 40 per cent.

But China's trade surplus has also made it one of the largest buyers of US Treasury bonds  which help to fund Washington's large budget deficit.

This is where the Americans face their greatest dilemma. If the yuan were to be appreciated disproportionately, as the United States wants, then Chinese exporters may end up getting lower dollar returns. Also, many of China's overseas investors may find it much more expensive to build or buy factories on the mainland, triggering a slowdown in its rate of economic growth.

But would this benefit the United States? A disproportionately appreciated yuan, if financed by the sales of US Treasury bonds, could trigger a run on the greenback. That, in turn, could mean higher inflation and higher interest rates in the United States  a possibility that sends shivers down American spines.

Are the Americans ready for that?