Peer reviewed analysis from world leading experts

Avoiding a US-China currency war: Need for rational calculation

Reading Time: 6 mins

In Brief

By 15 April, the US Department of Treasury was scheduled to decide whether to label China as ‘a currency manipulator’. The prospect of a trade war, or even worse a currency war, between the world’s two largest economies has further destabilised the shaky recovery growth of the global economy. Given the extremely complicated nature of the RMB exchange rate in the global economic context, the US should undertake a rational cost-benefit analysis instead of threatening sanction.

Since July 2005, China's RMB has appreciated by 21 per cent. But this has not significantly improved the US trade deficit, nor reduced China's trade surplus.

Share

  • A
  • A
  • A

Share

  • A
  • A
  • A

The driving forces of today’s exchange rate have gone far beyond bilateral trade. To understand what is happening, an analysis of the open global production and trading system is necessary. It is unlikely that further RMB appreciation, as demanded by some US congress representatives, can alter China’s status as ‘workshop of the world’ and substantially boost American exports.

While the US could experience limited economic gains if any form of sanctions are enacted, the Chinese economy will suffer serious damage. First of all, a surcharge tariff of 20 per cent or more will drive a large proportion of Chinese exports out of the U.S. markets, and will significantly reduce external demand; secondly, many workers in coastal export processing zones will lose jobs, resulting in slowdown of economic growth and social unrest; third, as more speculative capital enters China with a bet on RMB appreciation, the problem of an asset bubble in the Chinese economy will worsen and could spiral out of control.

A Chinese-US trade and currency war would threaten the entire East Asian economy. Goods marked as ‘Made in China’ have actually involved a collective division of labour across the region. In the past 15 years, East Asian economies including Japan, South Korea, Taiwan, Hong Kong and Singapore have moved their assembly lines to mainland China to take advantage of its cheap labour costs, and they continue to target their exports at the US market. As a result, these economies have greatly reduced their trade surplus with the US, while China is perceived as having the largest trade surplus. A trade and currency war between the US and Asia would therefore trigger significant knock-on effects for the region.

As China leads the world out of the recession, the Chinese economy has replaced the US economy as the greatest engine of global economic growth. Consequently, a Chinese-US economic war could undermine the faltering recovery of the global economy. For example, panic-induced capital holders could dump dollars and buy Euros, resulting in a substantial appreciation of the Euro. This is definitely not in Europe’s present interests. Among other consequences, it would exacerbate the impact of the Greek debt crisis on the EU economy.

What President Obama took office in early 2009, he sought to strengthen US-China cooperation on North Korea, Afghanistan and Iran; on global governance reforms such as IMF and the G20; and on climate change and anti-terrorism policies. Despite quarrels over US arms sales to Taiwan and Obama meeting the Dalai Lama, strategic cooperation between the two countries has remained strong. Faced with continuing global challenges, the United States needs China’s continued cooperation.

A unilateral US act (of citing Chinese currency) could trigger a trade and currency war; the political relationship would be severely damaged. A dispute over RMB yuan could, for example, have affected the participation of a Chinese leader in the upcoming nuclear summit hosted by the US government. The G20 meetings and the multilateral climate change convention could also face immediate hurdles because of mishandling this exchange rate issue.

Why does the United States continue to put pressure on RMB? And how likely is it that this pressure will lead to action? These questions can be answered by looking at US domestic politics and the recent diplomatic frictions between the two countries.

As the US mid-term election approaches, the weakening political support for Democratic Party and President Obama is evident. Maintaining a Congressional majority will be a difficult challenge for the Democrats. Scapegoating China is always helpful to domestic politics, as it diverts popular dissatisfaction with the Administration’s economic policies. Taking action on Chinese RMB would please voters who complain about the US’s high unemployment rate. On the other hand, China’s rapid economic rise is a source of public fear. It is politically good timing to ‘take on China’.

Threatening sanctions on RMB may have been regarded as saving ‘face’ on the recent bilateral diplomatic spats over the US arms sales to Taiwan and Obama’s meeting with the Dalai Lama. The Chinese government views Taiwan and Tibet as the nation’s ‘core interests’ and publicly condemned these moves. In the US, Chinese actions are now interpreted as ‘arrogant’ or ‘tough’, altering the former ‘low profile’ perception of China. Undoubtedly, the confrontation reflects some change in the relative power position between the two countries following the global financial crisis. The assumption can therefore be made that Americans want to teach the Chinese that the US is still the largest power in the world. This could be a game of ‘saving face’ in response to China’s ‘overreactions’ on Taiwan and Tibet.

This essay is not intended to discuss the merits of the RMB exchange rate appreciating against the US dollar from a theoretical perspective. The economic theories of exchange rates are conflicting, and there is no easy answer to this question.

One lesson we can learn from coming through the exchange rate dispute is that we are faced with an increasingly integrated global economy, and the global financial crisis and structurally imbalanced global economy indicate that the macroeconomic authorities of most countries have failed to adapt to this new reality. As a developing country, China has learned from the successful experience of export-led East Asian countries, and has pursued a stable exchange rate policy and a moderate accumulation of foreign exchange. But five to ten years ago, few could have predicted such close interdependence between the Chinese and global economies.

We must be extremely prudent about the impact of the global economy in which China, the United States, East Asia and other regions are closely linked. We have to handle the RMB exchange rate with rational analysis. There are signs which show that the US and China will find a sensible way to solve their problem and avoid the tremendous negative consequences to the recovering global economy. In the US, domestic political imperatives will hopefully give way to a more rational policy making process. A rational decision will benefit all economies, including that of the US.

Wang Yong is Professor, School of International Studies at Peking University, and Director of the Center for International Political Economy at the Peking University. Part of this article will be published in Beijing Review.

2 responses to “Avoiding a US-China currency war: Need for rational calculation”

  1. Wang Yong assumes that the US will gain moderately from a trade and currency war between the US and China. It is puzzling how that would be the case.

    Exports benefit an economy, so doe imports.

    What will the US gain from a reduction in the availability of cheap goods?

    What gains will Americans have if they have to pay higher prices for the same goods?

    What if China also takes retaliatory measures to restrict exports from the US to China?

    So it is difficult to understand the rationale of a possible US gain from a potential trade and currency war.

    Wang Yong’s presumption may have been based on the wrong premise that leads to the wrong conclusion.

    Of course, the US political circles have been used to threat other nations if they don’t follow its tune.

    One day it will wake up to the new reality that its past practice will work any more.

    That day may be very near now.

  2. As an american, I can tell you there’s little motivation to “take on china”. we just dont have that sentiment toward you. We dont see it as political either. We believe its something to do with banking and not something about china. Not a major emotional argument here in the US, trade with China. Most people understand prices will go up.

Support Quality Analysis

Donate
The East Asia Forum office is based in Australia and EAF acknowledges the First Peoples of this land — in Canberra the Ngunnawal and Ngambri people — and recognises their continuous connection to culture, community and Country.

Article printed from East Asia Forum (https://www.eastasiaforum.org)

Copyright ©2024 East Asia Forum. All rights reserved.