AFTER CANCUN, the next hot issue in international forums could well be China's exchange rate policy. Rather more generally, the exchange rate policies of all countries which actively intervene in forex markets to depress their own currencies and in the process build their forex reserves. India does not appear so far to have come on the radar screen of the G 7 (excluding Japan) which has now begun a systematic campaign against interventionist forex policies.
The flare-up over exchange rate policies once again shows how inextricably economics is linked with politics. It cannot be otherwise as both economics and politics are ultimately concerned with people in the ordinary business of life. And current forex rates policy, say in China, seems to be having a noticeably adverse impact on jobs in the G 7 countries — particularly in the U.S. and the Euro zone. And, of course, exchange rate adjustments are seen as a palliative (even if only for the short-term) to the problem of jobs destruction in the U.S. and the Euro zone.
U.S. and Euro zone arguments
Both the U.S. and the European Union now want China to abandon its policy of pegging the exchange rate of its currency, the yuan, against the U.S. dollar at a fixed 8.28 units. They have called for a revaluation of the yuan, commensurate with China's enhanced (and still growing) stature in the international economy.
First, the U.S. argument. This is not difficult to understand. America wants the yuan to be revalued so as to make Chinese goods costlier for American consumers and thereby make domestic goods more saleable. This, in turn, is expected to support domestic production and thereby help in the retention of domestic jobs.
The numbers here are quite significant and seem to support this argument. China has now emerged as the second largest trading partner of the U.S. after Japan. More importantly, it accounts for 20 per cent of the U.S. trade deficit and ranks first among nations with which the U.S. runs trade deficits. (For instance, the US has posted a trade deficit of $250 billion in the six months to June 2003 and China's share in that is $ 54 billion. This is higher than Japan's share at $ 32 billion and Germany's $19 billion).
As for the structural composition of the trade deficit, here too the trends appear to be turning adverse for the U.S. For long, one thought that the Chinese were dominant exporters of textiles, light engineering goods and toys to the U.S. market. Recent developments suggest that even manufacture of medium and heavy industry (with critical job potential) may be shifting into the low-cost base of China. Caterpillar, the world's largest maker of earth-moving equipment, recently went on record that a manufacturing base in China as a global supply base could be crucial for the company going forward. Global automakers such as General Motors and Daimler-Chrysler already have a full-scale manufacturing presence in China. (On a more macro plane, it is estimated that more than 50 per cent of all manufactured goods that Americans buy now are imported, up from around 30 per cent in the mid-1980s).
America does not have the time for structural adjustments of the type which can provide more than a transitory cure for its bulging trade deficits. More so with the Presidential elections due in 2004. Exchange rate adjustments are therefore seen as a panacea, even if only for the short-term.
The E.U. argument for a higher Chinese yuan is more interesting. A pegged Chinese currency against the U.S. dollar means that the Euro (the common European currency) is taking a disproportionate burden of adjusting for the massive US trade imbalance. That is, with the yuan not revaluing, the Euro has been revaluing also for it, in addition to any inherent forces that may be pushing the Euro higher against the dollar. And, of course, for major manufacturer exporters such as Germany (the locomotive economy in Europe), a strong Euro is a major bugbear.
The numbers here bear some emphasis. While the yuan has remained pegged at 8.28 against the dollar, the Euro is up more than 25 per cent in the past year and a half — it has zoomed from just around 89 U.S. cents early in 2002 to around 1.13 U.S. dollars now.
Sentimental comfort but bad economics
The mechanism of the Euro's upward adjustment consequent to a pegged Chinese currency is even more interesting. While on the one hand it could be comforting for the Euro's founders (who wanted the common currency to emerge as an alternative to the dollar as a reserve currency), it is bad economics as Germany teetering on a recession appears to indicate.
Quite simply, the massive hoard of dollars which countries such as China are accumulating from their trade surpluses with the U.S. is not fully lent back to the U.S. (as BoP capital account flows). A part of it or even a sizable part appears to be flowing into Euro-denominated assets. This is also contributing to the major upward thrust to the Euro in foreign exchange matters. This is what is meant when Euro zone authorities say that the common currency is now carrying a disproportionate burden of adjusting for the pegged yuan also.
Information flow from China is scanty. But the Reserve Bank of India has pointed out that valuation changes (from holding non-dollar assets in the forex reserves) account for 20 per cent of the increase (of around $ 17 billion) in India's forex reserves in the past year. It is quite likely Indian forex reserves management strategy now somewhat resembles China's.
The bottomline: not only is the Chinese peg hurting America, it is also becoming a major headache for the Euro zone, particularly Germany. The peg, though, may not be dismantled any time soon. In such a situation, given the magnitude of trade and investment flows emanating from China, one can reasonably expect the U.S. dollar to continue to remain weak against the Euro for some more time to come.
The flare-up over exchange rate policies once again shows how inextricably economics is linked with politics. It cannot be otherwise as both economics and politics are ultimately concerned with people in the ordinary business of life. And current forex rates policy, say in China, seems to be having a noticeably adverse impact on jobs in the G 7 countries — particularly in the U.S. and the Euro zone. And, of course, exchange rate adjustments are seen as a palliative (even if only for the short-term) to the problem of jobs destruction in the U.S. and the Euro zone.
U.S. and Euro zone arguments
Both the U.S. and the European Union now want China to abandon its policy of pegging the exchange rate of its currency, the yuan, against the U.S. dollar at a fixed 8.28 units. They have called for a revaluation of the yuan, commensurate with China's enhanced (and still growing) stature in the international economy.
First, the U.S. argument. This is not difficult to understand. America wants the yuan to be revalued so as to make Chinese goods costlier for American consumers and thereby make domestic goods more saleable. This, in turn, is expected to support domestic production and thereby help in the retention of domestic jobs.
The numbers here are quite significant and seem to support this argument. China has now emerged as the second largest trading partner of the U.S. after Japan. More importantly, it accounts for 20 per cent of the U.S. trade deficit and ranks first among nations with which the U.S. runs trade deficits. (For instance, the US has posted a trade deficit of $250 billion in the six months to June 2003 and China's share in that is $ 54 billion. This is higher than Japan's share at $ 32 billion and Germany's $19 billion).
As for the structural composition of the trade deficit, here too the trends appear to be turning adverse for the U.S. For long, one thought that the Chinese were dominant exporters of textiles, light engineering goods and toys to the U.S. market. Recent developments suggest that even manufacture of medium and heavy industry (with critical job potential) may be shifting into the low-cost base of China. Caterpillar, the world's largest maker of earth-moving equipment, recently went on record that a manufacturing base in China as a global supply base could be crucial for the company going forward. Global automakers such as General Motors and Daimler-Chrysler already have a full-scale manufacturing presence in China. (On a more macro plane, it is estimated that more than 50 per cent of all manufactured goods that Americans buy now are imported, up from around 30 per cent in the mid-1980s).
America does not have the time for structural adjustments of the type which can provide more than a transitory cure for its bulging trade deficits. More so with the Presidential elections due in 2004. Exchange rate adjustments are therefore seen as a panacea, even if only for the short-term.
The E.U. argument for a higher Chinese yuan is more interesting. A pegged Chinese currency against the U.S. dollar means that the Euro (the common European currency) is taking a disproportionate burden of adjusting for the massive US trade imbalance. That is, with the yuan not revaluing, the Euro has been revaluing also for it, in addition to any inherent forces that may be pushing the Euro higher against the dollar. And, of course, for major manufacturer exporters such as Germany (the locomotive economy in Europe), a strong Euro is a major bugbear.
The numbers here bear some emphasis. While the yuan has remained pegged at 8.28 against the dollar, the Euro is up more than 25 per cent in the past year and a half — it has zoomed from just around 89 U.S. cents early in 2002 to around 1.13 U.S. dollars now.
Sentimental comfort but bad economics
The mechanism of the Euro's upward adjustment consequent to a pegged Chinese currency is even more interesting. While on the one hand it could be comforting for the Euro's founders (who wanted the common currency to emerge as an alternative to the dollar as a reserve currency), it is bad economics as Germany teetering on a recession appears to indicate.
Quite simply, the massive hoard of dollars which countries such as China are accumulating from their trade surpluses with the U.S. is not fully lent back to the U.S. (as BoP capital account flows). A part of it or even a sizable part appears to be flowing into Euro-denominated assets. This is also contributing to the major upward thrust to the Euro in foreign exchange matters. This is what is meant when Euro zone authorities say that the common currency is now carrying a disproportionate burden of adjusting for the pegged yuan also.
Information flow from China is scanty. But the Reserve Bank of India has pointed out that valuation changes (from holding non-dollar assets in the forex reserves) account for 20 per cent of the increase (of around $ 17 billion) in India's forex reserves in the past year. It is quite likely Indian forex reserves management strategy now somewhat resembles China's.
The bottomline: not only is the Chinese peg hurting America, it is also becoming a major headache for the Euro zone, particularly Germany. The peg, though, may not be dismantled any time soon. In such a situation, given the magnitude of trade and investment flows emanating from China, one can reasonably expect the U.S. dollar to continue to remain weak against the Euro for some more time to come.
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