The Currency Albatross

By a conjuncture of events — from the Copenhagen spat to the war of words over Google, arms sale to Taiwan and US President Barack Obama meeting with the Dalai Lama — Washington’s ties with Beijing have been on a downward spiral. Since Nixon’s great opening, Sino-US ties have ridden roller-coaster but they have always recovered and grown stronger for one key reason: despite fundamental political differences, their fates have been increasingly bound together through the ever-intensifying integration of their economies. Now a new element makes resolution more difficult: long-term political stability in China and the Obama administration’s political future both ride on finding a solution to the economic crisis.

China’s protest about the US decision to sell $6.4 billion worth arms to Taiwan or about Obama’s meeting with the Dalai Lama is not new. Successive US administrations have fulfilled their Congressional mandate by selling Taiwan arms to defend itself, thereby incurring ritualistic Chinese protest. Meetings between American presidents and the Dalai Lama have provoked routine denunciation. But now, facing growing opposition in the Muslim-majority Xinjiang and in Tibet, China has become more strident in defending what it calls its “core issue” of sovereignty.

Meanwhile, current economic tensions between Washington and Beijing over the latter’s currency policy and massive trade surplus touch upon another unspoken core issue: the political legitimacy of one-party rule that relies on steady economic growth and job creation. Over the past three decades, the Chinese Communist Party has won the loyalty and support of Chinese citizens by delivering prosperity based on export-driven, double-digit growth. Some 20 million were thrown out of work because of falling exports, to that one has to add three million unemployed university graduates with little prospect for the future. Chinese leaders are seeking every avenue to relieve the social pressure that is building up.

Hundreds of thousands of Chinese workers have been sent to work in Africa. Economic stimulus provided to Tibet is providing more jobs for ethnic Han Chinese who flock there. China’s massive stimulus spending has created a temporary boom in the construction sector, but domestic consumption remains hobbled by other factors. The export engine still remains the main tool to create jobs and its success depends, to a large extent, on keeping the value of its currency low, making Chinese-made shoes, textiles and camcorders competitive. To give in to world pressure and revalue the renminbi not only makes the Chinese government look weak in the eye of its citizens, but also takes away a proven tool to boost exports and create jobs. In order to keep inflation down, China may undertake small revaluation but that is unlikely to placate voices calling for substantial revaluation.

The renminbi, estimated to be undervalued by 25-40 per cent, is a bone of contention between China and the US. The artificially low currency, which acts as an effective subsidy to Chinese exporters, has raised complaints in the past, but since the havoc caused by the 2008 financial crisis, it has shot to the top of Washington’s list of concerns. With 15 million officially jobless, reviving the US economy and especially exports, has become the most critical issue. Chinese mercantilist policy is increasingly seen as a major obstacle to the US recovery. Nobel laureate economist Paul Krugman has made a ‘back-of-the-envelope assessment’, which concludes that the negative shock resulting from the Chinese policy to rest-of-the-world net exports is loss of 1.4 per cent of GDP. He calculates that it translates to 1.5 million lost jobs in the US alone. Whether accurate or not, in the months leading to the 2010 mid-term Congressional elections, China is certain to be held responsible for some of America’s economic distress. If it refuses to revalue its currency, the administration is likely to add more tariffs on Chinese imports. It is a measure of global interconnectedness that Chinese economic policy could influence, even if in a minor way, the electoral prospects of an American political party. Democratic losses in November would erode their Congressional majority and seriously handicap the President’s legislative ambitions for the remainder of his term in office.

China seems to be counting on low renminbi to stimulate growth and keep discontent at bay, but double-digit growth in Chinese export and double-digit unemployment in the US may be politically unsustainable in an election year.