China Shouts Fast, Moves Slowly In Currency War With U.S.

China will play its usual defense against the moves in the U.S. Senate to twist Beijing’s arm to appreciate its currency against the dollar: vociferous denunciation of Washington for turning protectionist and initiating trade wars while patiently waiting out the start of any actual hostilities, calculating that they will eventually recede.

The denunciation has duly come with Foreign Ministry spokesman, Ma Zhaoxu, saying the bill now in front of the U.S. Senate proposing punitive measures against any country that is shown to be manipulating its currency — for which read China — “seriously violates rules of the World Trade Organization and obstructs China-U.S. trade ties”. He told U.S. Senators to abandon protectionism and stop politicizing economic issues. He also told them to “stop pressuring China through domestic law-making”. Similar sentiments have been expressed by the central bank and the commerce ministry.

While perhaps nobody outside the U.S. Congress really believes that a sharp revaluation of the yuan on its own will eradicate America’s trade deficit with China or create the new domestic jobs the U.S. is having such trouble generating, Beijing will know that even if the Democratic majority in the U.S. Senate passes the bill, the legislation will likely founder in the Republican controlled House of Representatives. Even if it does not, it is highly unlikely to survive a presidential veto. That is the past pattern of such proposed legislation. Support for this year’s bill appears to be stronger, helped by its narrower provisions and the background of sluggish U.S. growth and joblessness, but the odds remain long that it will become law.

At the very worst, and the bill does become law, it will be cheaper politically for Beijing to fight any punitive measures through the WTO than it would to be seen to capitulate to foreign pressure. Meanwhile, it can bide its time, letting the gradual appreciation of the yuan that has been underway since June last year (up 7% against the dollar since then and 10% against the euro) ease the U.S. pressure that is anyway likely to abate after next year’s U.S. elections, while buying more time for the economy, particularly the export-manufacturing sector, to adapt.

China’s policymakers are quite happy for the yuan to appreciate. It will help them both fight inflation and restructure the economy. But they want do it to their timetable, not Washington’s — and they have the playbook to do that.

China’s April Export Surge Adds To Pressure On Yuan

Bad timing. China’s trade surplus for April came in at a larger than expected $11.4 billion as exports surged and imports were lower than expected. Exports grew 29.9% year-on-year to $155.7 billion while imports rose 21.8% to $144.26 billion. The numbers were announced between days one and two of the latest round of the China-U.S. Strategic and Economic Dialogue being held in Washington. They will provide fresh ammunition for U.S. critics of China’s tight management of its currency and increase the pressure on Beijing to allow faster appreciation of the yuan. China’s defense, that it recorded its first quarterly deficit in seven years in the first three months of this year, will be overwhelmed, though the central bank has been allowing the yuan to rise as part of its own anti-inflation fight. What is complicating that for it is the fact that while the yuan has gained more than 2% agains the dollar in the past six months, it has lost ground against other leading currencies as the dollar has weakened.

Footnote: Note for the watch-list: does April’s weak imports number reflect a slowdown in the economy or a running down of inventories, particularly of price-spiked commodities?

First published on China Bystander.

Beijing Takes Another Step To Internationalize Its Currency

Bank of China’s new if limited yuan trading facility for its U.S. customers is another small step in the direction of internationalizing the currency. It is the first time customers can to buy and sell yuan using accounts at the state-owned bank’s U.S. branches, rather than go through Hong Kong. A limit of 20,000 yuan ($3,000) a day can be bought per individual’s account, the same cap that applies in Hong Kong to limit speculation. Business accounts are uncapped.

Beijing has been pushing its importers and exports to settle trade less in dollars and more in yuan, and allowing the development of an offshore market in the yuan. Cross-border trade settlements in Hong Kong grew from an average of 4 billion yuan a month in the first half of last year to 68 billion yuan in October. China Bank of Construction forecast recently that this number could reach 1.6 trillion yuan a month by 2015. However, the trend is more pronounced in the trade with countries other than the U.S.

Nevertheless, it has helped swell the yuan deposit base in Hong Kong to 260 billion yuan at end-November 2010, and the introduction of markets in the currency and of yuan-denominated financial instruments, including so-called dim sum bonds. Trading in the currency was allowed in Hong Kong last July. Daily trading has now reached $400 million. Given $4 trillion is the total of all daily currency trading, the internationalization of the yuan still has a long way to go, but it is clear where it is headed however cautiously.

The post was first published on China Bystander.

Dollar’s Rise Rebuffs U.S. Fed’s Critics

One international criticism of the U.S Federal Reserve’s second round of quantitative easing announced at the beginning of last month was that it would weaken the dollar, and that that was the intention of the Fed to boost the U.S.’s international competitiveness. In the event, the dollar has strengthened over the past month, by 5.2% on the Dollar Index. The economic data out of the U.S. has been more positive and sovereign-debt concerns in Europe have undermined the euro, a key component of the Index. Fed officials, if not American exporters, must be feeling quite chuffed.

G-20 Finance Ministers Look Set At Odds

Prospects for the G-20 calling a truce in the currency wars seem remote. Reuters news agency is reporting that China, India and Germany are rejecting out of hand a U.S. proposal to set numerical targets for trade surpluses and deficits at the G-20 finance ministers meeting in Seoul this weekend.

The American proposal would put far too much flesh for the taste of the surplus nations on the bone of a mom-and-apple-pie agreement among the G20 a year ago that big surplus countries like China would aim to shift growth away from being export led while the big deficit economies like the U.S. would seek to boost domestic savings. We expect the communiqué to be issued after this weekend’s meeting will be long on good intentions but short on any agreed measures — let alone commitments — to make good on them, not the ideal preparation for the G-20 leaders’ summit next month.

Currency Wars: When Pachyderms Oppose

The leaders of the G-20 nations will meet next month in Seoul to attempt to defuse tensions over competitive devaluation by governments — the currency war of the tabloid headlines — that their central bankers and finance ministers were unable to resolve at last weekend’s annual meetings of the International Monetary Fund and the World Bank. At this point the prognosis is not good. The consensus and cooperation that was there at the start of the global financial crisis continues to evaporate.

Host South Korea, as Japan’s finance minister has mischievously pointed out, is one of the countries that “regularly” intervenes in foreign exchange markets, but it is China’s foreign exchange-rate policy that will be the elephant in the room, as it was at the IMF meeting. The pace of the yuan’s appreciation against the U.S. dollar since China again loosened its peg with the greenback in June (2.4%) has been insufficient for the critics who accuse China of keeping the yuan cheap to protect its exporters.

If China’s most recently posted trade surplus of $120.6 billion dollars in the first nine months of 2010, 10.5% lower than in the same period a year earlier, hasn’t assuaged China’s critics, then the largest quarterly increase in the country’s foreign exchange reserves in the third quarter, $194 billion, thanks to the persistently large trade surplus and capital inflows, is only likely to inflame them, providing further evidence that the yuan is undervalued.

The new factor is the beggaring of neighbours. U.S. Treasury Secretary Timothy Geithner says that that the yuan’s undervaluation is forcing other developing countries that supply China to attempt to halt the appreciation of their currencies, too. What Geithner did not say was that it halting his country’s attempts to devalue its way to export growth, too. For those with even longer memories than ours, the calamitous competitive devaluations of the Great Depression come into prospect.

Beijing has been candid about the damage it believes a rapid upward revaluation of the yen would to do its exporters, citing that as its reason for moving cautiously. It continues to remind anyone who will care to listen, though its words mostly fall on deaf ears in the rich countries, that there are other sources of the current global imbalances, such as huge fiscal deficits and unconventional monetary policy in the developed economies.

We are likely to be hearing more of that refrain. In the U.S., the Federal Reserve is expected to embark soon on another wave of flooding the U.S. economy with money, the so-called second round of quantitative easing (“QE2”). The Fed’s strategy for stimulating a recovery that is stubbornly sluggish, if not unexpectedly so given the de-leveraging the U.S. economy has undergone, is to inflate the economy and depreciate the dollar by a combination of running negative real rates (nominal rates are already as close to zero as makes no difference) and quantitative easing.

This is not with our risk. So much world trade is denominated in dollars, as the only global reserve currency, that price inflation of commodities like oil is inevitable. That may not worry Americans so much (yet; but wait for $200 crude), as fighting off deflation is their immediate concern, but it sure worries emerging economies that are not natural-resources exporters, such as China, where inflation is the more pressing concern.

The double hit that quantitative easing in developed economies lands on emerging economies is that it will increase their inward capital flows, potentially inflating asset bubbles, making more probable further intervention in foreign exchange markets to forestall that. The Institute for International Finance forecasts net capital inflows into emerging economies of more than $800 billion in 2010 and 2011.

Governments usually respond to such potentially disruptive capital inflows with some mix of the three policy tools they have available to them: intervention in foreign-exchange markets; the imposition of taxes and controls on the capital flows directly; or doing nothing–letting their currency appreciate and take the hit to their export competitiveness. Neither is a particularly palatable choice, particularly for export-driven emerging economies. We are likely to see all three in some form if the “currency wars” continue.

The long-term solution is well-known,  high-spending, high-deficit developed economies need to get their fiscal houses in order while the real exchange rates of the surplus economies need to appreciate and domestic demand expanded to offset the effect on exports. Getting there is the difficult part.

Not only has the journey barely begun, the kids are already bickering in the back seat. Instead of the sort of co-operation among governments that marked the early days of the global financial crisis to coordinate an orderly adjustment of exchange rates and external accounts (pace the IMF pulling an unlikely rabbit out of the hat before the G-20 summit), each is starting to go its own way. The U.S. is resorting to the instant creation of money, as it uniquely can as it has the world’s only reserve currency (oh, that we could all increase our bank accounts at the touch of a button as the Fed can). China is resisting in the way it knows best, controls, in this case on its exchange rate by having its central bank tightly manage the bands in which the yuan can move.

At the same time, China’s leaders, who have a historic fear of inflation and who know well what it can do for ill to the country’s rulers, believe that the way to make the underlying adjustments to real exchange rates that everyone agrees is necessary long-term is through falling domestic prices in the U.S. That would be similar to the sort of deflationary austerity on the U.S. that is being wished on Greece. That may not be politically acceptable in the U.S. any more than inflation would be politically acceptable in China. But inflating away the world’s global imbalances vs deflating them away are fundamentally opposite policies. The standoff between the two is worsened because deflation in the U.S. would be as bad for China as inflation in China would be for the U.S.

Both threaten to send the global economy into reverse. That all makes a G-20 agreement on exchange rates ever more necessary as a dampener on rising protectionist spirits in the developed economies and the rising nationalism in China among those who see the economy as primarily a matter of national security.  When elephants fight, as the Swahili saying goes, the grass gets trampled. Unfortunately, that doesn’t make an agreement in Seoul any more likely. The best that can be hoped for is that the grass will be left in good enough condition to spring back up again.

Talking The Yuan-Dollar Rate Up, Down And Sideways

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U.S. Treasury Secretary Timothy Geithner (left) didn’t speak softly when appearing before Thursday’s U.S. Congressional committee hearings on whether the U.S. should impose trade sanctions on China on the grounds that its currency policy amounted to an illegal export subsidy. But he also didn’t say he would be immediately reaching for the big stick to get Beijing to let its currency rise against the dollar. “The pace of appreciation has been too slow and the extent of appreciation too limited,” he told increasingly impatient American lawmakers. “We have to figure out ways to change behavior.”

The Obama administration has an uncomfortable path to go down while it figures. Washington politicians, in the midst of a mid-term election season being shaken up by anti-incumbent Tea Party activism, are becoming shriller about the perceived effects on the U.S. economy of China’s exchange rate policy, even though, as Chinese officials and many economists point out, letting the yuan appreciate won’t in itself reduce the U.S.’s deficits and unemployment rate. Or at least not unless the appreciation is of an unimaginable order of something like 50%. The world economy is anyway not robust enough to stand the shock that that scale of adjustment would have on China’s labour-intensive industries were it to come about in short order, not that Beijing would let it.  China’s central bank has repeatedly spoken of the need for currency stability, and warned of the risk of commodity and asset bubbles in the event of a rapid appreciation of the yuan against the dollar.

The central bank has been as good as its word.  The yuan has risen less than 2% since it was unpegged from the dollar in June, nearly a half of that coming in the week ahead of  this week’s Congressional hearings, on which Beijing was well briefed by visiting U.S. officials such as Larry Summers last week. Geithner on Thursday tried to distance the administration from Congress’s wilder animal spirits, saying that the new proposed legislation on trade sanctions was a “complicated” idea that needed further study; similarly he will resist naming China as a currency manipulator in the U.S. Treasury’s next biannual foreign exchange report, due in October ahead of the G-20 Seoul heads of government meeting, a declaration that would automatically trigger punitive measures.

With the U.S. economy recovering from the global financial crisis only slowly, and likely to be facing an extended period of sub-par growth the last thing the Obama administration wants is a trade war to further complicate the U.S.’s relationship with China that has so many potential points of tension already. What it prefers to do is push trade complaints into the slow lane by sending them to the World Trade Organisation, as it did with two new cases earlier this week.

That is, self evidently, a different timetable to the one on which American politics is now operating. Chinese officials may think they will be able to ride it out until November, and as always will be stubborn about being seen to be giving into foreign pressure. China, too, has its own election timetable in play, in which the pace of economic recovery plays just as important a role as it does in the U.S., regardless of the different pace of growth in the two countries.

In truth, the U.S. cannot just devalue its way back to economic rude health. Washington isn’t alone in complaining about Beijing’s exchange rate policy. But fixing the global economy, and the huge imbalances that still exist within it, needs more than just a deal on exchange rates, bilateral or global, just as fixing America’s huge trade deficit with China will take more structural reform than the official Chinese buying missions that are being dispatched to the U.S. or pre-election grandstanding by worried American politicians.

This post was first published on China Bystander.

China’s Regained Momentum Gives Yuan Room To Strengthen

On Tuesday, the yuan hit its highest level against the U.S. dollar since Beijing scrapped its currency peg in July 2005 and indeed its highest level since the official and market exchange rates were merged in 1993. Today, the U.S. Congress discuses China’s currency policy, one many American lawmakers believe that Beijing rigs. Congress is considering a bill proposing trade sanctions against countries that “misalign” currencies.

The yuan has now risen half a percentage point on the foreign exchanges over the past three trading days, a strengthening that will be seen as a friendly gesture in Beijing but a meaningless one in Washington given the dollar-yuan exchange rate’s lack of movement for months in the face of U.S. jawing (quietly on the part of the Obama administration, noisily in the legislature.)

Yet, away from the political rhetoric, as Prime Minister Wen Jiabao said at a World Economic Forum meeting in Tianjin, China’s economy is in “good shape, featuring fast growth, gradual structural improvement, rising employment and basic price stability.” August’s industrial production and retail figures suggested the economy has regained momentum and that the slowing that followed the monetary tightening earlier this year was relatively short lived. Pace the continuing risk of asset bubbles, as Wen touched on with the housing market, that gives policy makers in Beijing more scope to let the yuan appreciate, though they will continue to do so to their own timetable more than Washington’s.

This post was first published on China Bystander.

Watch What China Does, Not What It Says About Yuan-Dollar Rate

Pay less notice to China’s latest monthly industrial production and retail sales figures — both up 16% in October from a year before, with the trade surplus almost doubling from September, to $24 billion, as the contraction in exports eased to its slowest pace this year — and more to the subsequent statement by the People’s Bank of China that foreign-exchange policy will take into account global capital flows and changes in major currencies.

The central bank has been saying recently that the aim is to keep the yuan stable, and has effectively re-pegged the currency to the U.S. dollar after letting it appreciate 20% against the greenback since cutting its peg in 2005, not so much to boost exports as to maintain the value of its U.S. dollar denominated assets.

Does the change in language indicate the central bank is preparing to let the currency strengthen as the economy recovers in the face of growing world criticism such as that at the weekend from the IMF which said China’s currency is “significantly undervalued”? Or is it more a symbolic gesture ahead of U.S. President Obama’s forthcoming visit during which the dollar will be a topic of discussion? We suspect the latter, and are sure that if there is change it will happen slowly and gradually.

What seems more certain is that the central bank is preparing to rein in some of the lending it has encouraged to stimulate the economy. A lot of that money has found its way into frothy looking equity and property markets, which worry policy makers in a way consumer inflation doesn’t. Credit growth eased in October. New loans fell to RMB 253 billion from September’s RMB 517 billion, though the fourth quarter usually sees new lending dialed back. Late last month, the State Council said that monetary policy would remain “appropriately loose”. Now the central bank is saying “moderately loose“, for which read tighter, if only a bit more than what we have already seen since summer.

Oiling The Decline Of The Dollar As The World’s Reserve Currency

More on the dollar and its growing role as the fault line of the China-U.S. relationship: China, Russia, Brazil, France and the Gulf States are plotting to switch global oil trading out of dollars, according to Robert Fisk writing in The Independent. Instead they would price oil against a basket of currencies and gold. Secret meetings of finance ministers and central bankers to this end have been held, Fisk says.

What is no secret is that less of the world’s oil trade is priced in dollars than was once the case as buyers and sellers have sought to dampen the volatility that the dollar has exhibited in recent years. The mechanics of pricing oil against a basket of currencies and commodities would be a nightmare, unless the IMF’s special drawing rights (SDRs) or some close facsimile become a widely accepted currency, which this Bytander doubts will happen anytime soon. And what constitutes a secret meeting when it comes to finance ministers and central bankers getting together is another thing of definitional fuzziness.

Saudi central bank governor Muhammad al-Jasser has flatly denied The Indie’s report, saying there have been no such discussions secret or otherwise. Japan’s finance minister Hirohisa Fujii said much the same. But it is certainly no secret that China, along with some other leading developing economies, is steadily chipping away at the notion that the dollar should be the world’s sole reserve currency, and with it the U.S. sway over the world economy.