Freeing the Renminbi

The rising tensions between China and the US over the undervalued renminbi have subsided. Awareness about the dangers of a trade war has encouraged cooler heads to prevail — for now. However, the issue remains live and, with US congressional elections just months away, is prone to flare up. Policy makers face a paradox when it comes to the yuan: allowing it to appreciate would solve one problem, but create others.


The immediate crisis has been defused with Washington postponing judgement on whether to name China a “currency manipulator” and impose mandatory high tariffs. Beijing has, for its part, offered soothing assurances about plans for gradual appreciation of the renminbi. But as the possibility of higher-cost Chinese exports appears ever closer, it becomes apparent that the unintended consequences would affect others as much as China. In addition to increasing consumer prices in the US, such a revaluation would certainly affect employment rates among China’s Asian neighbours, whose economies are closely integrated with China’s export machine.


It is easy to understand America’s frustrations. Since joining the WTO, China provides one-fifth of American imports, but buys only 7.4 per cent of US exports. It has built up a bilateral trade surplus of $226 billion and, in the process, emerged as America’s banker. Some critics have charged that China’s massive trade surplus has cost the US millions of jobs, as cheap Chinese labour lures US firms to offshore their production.


Would revaluation of the renminbi redress these trade imbalances? Americans could pay higher prices for clothing and other goods. However, most American imports from China are parts, components, and semi-finished goods to be assembled and sold in the US or exported on. A study by the Centre for Economic Policy Research — a consortium of European researchers — concluded that an appreciation of renminbi would reduce US real wages and shrink employment. It may also be unrealistic to expect that a weakened dollar will encourage China to buy up more American products. The high-technology goods with possible military applications that China desires are off-limits.


A stronger currency would hit China and the international supply chain supporting its export operation. A fall-off in Chinese exports would deal a particularly strong blow to its regional suppliers. Indeed, China has in recent years exported increasingly sophisticated electronic products and other consumer goods built with heavy machinery from Japan and South Korea, and fuelled by raw material, energy and components imported from Australia and South-east Asia.


The composition of Chinese exports is such that the conventional logic of a currency revaluation ceases to apply. In theory, a strengthened renminbi would lead China into an import binge and reduce its trade surplus. In reality, however, the slackening of world demand because of higher-priced Chinese goods would only reduce Chinese imports from abroad. The CEPR study estimates that a 10 per cent rise in the value of the yuan could see China cut imports of components by as much as 6 per cent. Likewise, most other Asian exporters couldn’t take advantage of falling Chinese exports as their own exports are typically complementary goods rather than substitutes for Chinese products.


The probable effects of a drop in Chinese exports can also be guessed by reversing the analysis about how China’s gross domestic product (GDP) growth impacts the exports of its trade partners. Modelling by economist Barry Eichengreen and his colleagues based on data for the period between 1990 and 2003 shows that a 10 per cent rise in China’s income leads to a 4 to 5 per cent increase in exports for countries such as Japan and Singapore. Even India, a relative latecomer as a supplier of raw materials to China, would see a 2.3 per cent bump in exports. 


Bangladesh, Cambodia and Sri Lanka, on the other hand, would see a drop in their export earnings as they lose out to cheaper Chinese goods. By turning the scenario the other way round, it is reasonable to assume that the rising prices of Chinese consumer goods resulting from a future currency revaluation would enable these producers of cheap consumer goods to increase their exports.


Washington and Beijing need to recognise that the value of the renminbi has ripple effects. In today’s inextricably interdependent world, redressing global imbalance requires a multilateral solution and not a quick one-sided action.