International | Aug 08 2007
By Greg Peel
China has often been curt in the past year when dealing with constant US pressure to allow the renminbi to revalue at a more rapid pace. Yesterday Beijing turned the heat up another notch.
China’s trade surplus with the US continues to grow, and its holding of US dollars continues to grow, despite all the softly-softly fiscal and monetary measures taken by the Chinese government over the last few years. The renminbi is pegged within a trading range against the US dollar, at a level which represents significant undervaluation. This has allowed China’s export industry to explode into the force it is today.
The US is the largest buyer of Chinese exports. The US has also outsourced much of its production process to China in order to take advantage of minimal wage costs. US companies have invested in the Chinese growth machine. In turn, China has parked the vast majority of its foreign reserves – garnered from its global export sales – into US Treasuries. As Americans have lapped up Chinese exports, the US has built an historically large current account deficit. In short, China funds US spending.
The result has been the loss of US jobs in traditional manufacturing industries and, as far as the US is concerned, a perilous debt situation. It also hasn’t helped that recently many Chinese exports, from toothpaste to toys, have found to be compromised in quality and in some cases downright dangerous. There has been a build up of support on Capitol Hill from both sides of government to introduce protectionist measures as a means of forcing Beijing’s hand. This has not been well received.
The wave of support is building momentum as presidential favourite Hillary Clinton hitches her wagon to the anti-China train. This now has Beijing very concerned.
“Thanks to the trade surplus, China has accumulated a large sum of US dollars, and China’s foreign exchange reserves, the world’s largest, are mostly in US dollars,” said He Fan, an official at the leading Communist Party body the Chinese Academy of Social Sciences, in the China Daily. “Such a big sum, a considerable portion of which is in the form of US treasury bonds, contributes a great deal to maintaining the position of the US dollar as an international currency.
“But the Chinese central bank will be forced to sell US dollars once the renminbi appreciates dramatically, which might lead to a mass depreciation of the US dollar against other currencies.”
In other words, you force an appreciation – we trash your currency. And China has every opportunity to do so simply by selling out of its massive US treasury holdings, just as the likes of Russia, Switzerland and several other countries have begun to do.
But what Fan is most eager to point out is that the real loser in any attempt to force Beijing’s hand will actually be the US itself.
If the renminbi appreciates too fast, Chinese exports will be reduced. The US will then need to turn elsewhere for its necessities and may not find cheaper. The US international balance will not be improved.
If China loses market share, economic growth will slow, thus reducing demand for US imports. Neither will this improve the trade deficit.
If the renminbi appreciates, profits from US investment in China will be eroded.
“As a matter of fact,” said Fan, “the US has more to gain if China maintains the renminbi at a stable level”.
The London Daily Telegraph’s Ambrose Evans-Pritchard notes Chinese state media is calling any move by Beijing to start selling US Treasuries as the “nuclear option”. Perhaps not the best choice of phrase, but the implication is obvious. As Evans-Pritchard suggests, such action could trigger a US dollar crash at a time when the US currency is already breaking down through historic support levels.
“It would also cause a spike in US bond yields,” notes Evans-Pritchard, “hammering the US housing market and perhaps tipping the economy into recession. It is estimated that China holds more than US$900 billion in a mix of US bonds.”
He Fan’s China Daily interview backs up comments made last week by finance chief at China’s Development Research Centre (which holds cabinet rank). Xia Bin suggested Beijing’s foreign reserves should be used as a “bargaining chip” in talks with the US.
Hillary Clinton has called for legislation to prevent America being “held hostage to economic decisions being made in Beijing, Shanghai, or Tokyo”. With foreigners controlling 44% of the US national debt, America is acutely vulnerable. One US currency strategist has said, the Telegraph reports, that Clinton is sending a message to the US Senate as legislation is prepared for the August session.
“The words are alarming and unambiguous. This carries a clear political threat and could have very serious consequences at a time when the credit markets are already afraid of contagion from the subprime troubles,” he said.
There is already draft legislation in place, calling for trade tariffs on Chinese goods. US Treasury secretary Henry Paulson has suggested any such sanctions would undermine US authority and could trigger a global cycle of protectionist legislation.
The threats on Capitol Hill last week prompted a group of in excess of 1,000 economists from both sides of the political fence to implore politicians not to go down the protectionist path. The last time such a group took such measures was to campaign against Herbert Hoover’s intended equivalent actions. He ignored the advice and went ahead anyway. Therein followed the Great Depression.
