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The US-China Currency Dispute

Post By gaia1 in Exchange rates

          While the Chinese currency policy caused tensions in the early 1990s, it became highly contentious in March 2010 when the world’s economy was still reeling from the devastation of the financial crisis of 2008. It reached fever pitch when Chinese premier Wen Jiaboa declared on March 13 after the closing of the annual legislation session of the National People’s Congress that the yuan was not undervalued and that Chinese currency policy was based upon a “managed market-oriented” approach of floating exchange rates. The only linguistic difference with his terminology and that one President Obama was the term “managed”.


          Within days, particularly in the USA, a bevy of dramatis personae got involved: President Obama, US Treasury, 5 Senators, 130 House members, the New York Times columnist Paul Krugman and its editorial board. Probably, so many more newspapers, magazines, talk shows, blogs will get involved, all either declaring the Chinese currency policy currency to be manipulation or demanding to have the U.S. government declare it currency manipulation, so that import duties can be levied against this flagrant violation of free trade.


          Is this currency conflict to be considered a minor spat or a major issue that deserves all this attention in both the US, Europe and elsewhere? What can be done about it if it is considered a major international issue?


It first of all shows how important the international monetary system is, because floating, market oriented exchange rates are an essential component of the present “non-system” of international monetary relations and “managing” them violates even this “non-system”. During these hard economic times when each nation is desperately trying to create opportunities for restoring economic well-being and placing (inordinate) confidence in the job-creating function of their international trade policies, the undervalued yuan creates an unfair advantage for China that reduces the chances of global recovery and adversely affects the importing country. Thus, this out-of-balance international monetary system not only affects international trade, but also the world economy. It shows how the international monetary system is the glue of the other systems and, if it does not work properly, the whole system becomes unglued.


Secondly, China’s reserves stood at $2.4 trillion at the end of 2009 of which $900 billion are in dollar-denominated US Treasuries—a large pool of assets the sudden changes of which could be disruptive in many ways, both for China and the US. Columnist Krugman believes that the US has China over the barrel rather than the other way round. The US could withstand sudden shifts away from the dollar while China would be holding devalued dollars. The system as a whole would be unstable for some time.


Thirdly, the currency dispute can become a protectionist tool during these times of recession and unemployment. It ties in with world wide stimulus plans. (China has started to describe its currency interventions as stimulus.) But unlike extra stimulus spending Chinese currency interventions do not expand global demand, but shift it from other countries to China. Moreover, it was decided in Pittsburgh that the G20 economies would share their economic plans, so that the world would not lurch from recession into protectionism and inflation.


The vehemence of most of the responses, present ones and future ones, shows that the issue is considered a major issue that could test the fragile cooperative mode among the G20 and could lead to sanctions not only in the US, but also Britain and the EU. It could even result in having the WTO adjudicate (behind close doors) the issue at considerable financial costs because of its expensive procedures. At the same time, Rome is burning and the millions of unemployed persons are not helped by this fracas.


          Is the Ex EU president and ex Italian premier Podi correct in advising the world to stop nagging China and to get accustomed to the assertive policies of an emerging nation? I think he is underplaying the severity of the impact of its currency policies, perhaps also due to the fact that is guest teaching in a Chinese university.


Premier Wen made clear during this over 2 hours news conference for Chinese and foreign journalists  that China is defending against “finger pointing” and charged developed countries in forcing unfair  changes by “just for the purposes  of increasing their own exports”. “I understand that some economies want too increase their exports, but what I don’t understand is the practice of depreciating one’s own currency and attempting to force other countries to appreciate their own currencies, just for the purpose increasing their own exports.” Wen believes that such policies are cause for alarm because it amounts to trade protectionism. He also believes that it is matter of “national credibility” for the US to protect its dollar. “With regard to monetary policy, it is important for us to maintain appropriate and sufficient money supply, keep interest rates at a reasonable level and manage inflationary expectations." He also pointed to the feasibility of working together. "China's total trade is high, but 50 percent is processing trade, and 60 percent of China's exports are made by foreign enterprises or joint ventures. If you restrict trade with China, you are hurting your own countries' firms."


          What has to happen, first, is to establish for a fact whether the yuan policies are manipulative or not. The IMF was called upon to investigate. As a matter of fact it already did investigate the issue and concluded that the currency is “substantially undervalued.” However, this investigation is not made public by China who has the right to suppress it. Having acquired a recent seat at the IMF that is appropriate according to its economic status it used its power as other nations would have done. According to the US based Peterson Institute of International Economics’ executive director Bergsten the yuan is undervalued by 20-40%.


          What has to happen next is to question the international monetary system which is unable to deal with an important nation’s unfair currency policies in an effective way. Probably, some accommodation will be found and the stage is set for another fracas where the accommodation is less likely to be forthcoming. In other words, what is needed is thorough reevaluation of the international monetary system, particularly its global reserve system.


          Nobody among the loud American voices on this currency dispute has pointed out that part of the problem is the US dollar being the world’s major reserve currency that contributes to global financial imbalances, particularly the surplus of about $1 trillion in Chinese coffers. By having a non-national reserve currency, the U.S. government would not be able to sell its Treasuries for .5% and fund its huge deficits and China would not have those surplus dollars.


          Under the TFD system scenario an enormous, i.e. transformational step would be taken, far surpassing, but including the currency problem of manipulation and, also, of currency speculation. As a matter of fact, the TFD system goes beyond the monetary challenges and combines them with the climate challenges, which are even more demanding.


Under the TFD system, in phase 1,  the global reserve system would be based a carbon-based international reserve currency of the Tierra, removing dollars, euros and yens into a nation’s economic activity. The reserve Tierras are convertible only with its own currency, not with other currencies. So in this phase greater financial independence is created, since a nation’s reserve system is not bound to another nation’s currency. Moreover, given that the UN Tierra International Clearing Union monitors financial flows, nations have a better idea of how to cope with financial flows.


In phase 2 the international monetary system as a whole would operate on the carbon-based international vehicle currency of the Tierra and regulate financial flows under the control of the UN World Central Bank. In this phase its transparent and democratic Board of Governors is able to discipline a nation if necessary. However, that would be an exceptional case, because the monetary and fiscal procedures that were established by the Articles of Agreement of the Tierra Treaty are fair and stable.