ECONOMYNEXT – The volatility in China shows the futility of misguided US policy to force Yuan’s appreciation in a failed bid to lower a trade deficit, which can also damage the Asian nation, a top international economist has warned.
Mercantilists in Washington have for years claimed that China was ‘manipulating’ or ‘undervaluing’ its currency to boost exports and that it was generating a trade deficit with the US.
After a steep fall in 1994, China improved her monetary policy and fixed the currency to the US dollar at 8.27 Yuan. During the next 10 years, the country progressed steadily with inflation levels in step with the US and strong and stable growth.
"Pressure from the U.S. and many nonsensical mercantilist’s arguments caused China to abandon fixity in 2005," writes Steve Hanke, Professor of Applied Economics at Johns Hopkins University, Baltimore in the September 2015 issue of Globa Asia magazine.
"The wrong-headed thinking in Washington is that exchange-rate flexibility in China would result in an ever-appreciating yuan against the greenback.
"Forget all the talk about the glories of a market-determined, flexible exchange-rate. That rhetoric is just a cover for Washington’s real agenda: an ever-appreciating yuan."
From 2005, the Renminbi was appreciated from 8.27 Yuan to under 6.1 by early 2014.
Mercantilists in Washington had strong-armed Japan to do the same from to try and reduce its trade deficit before jumping on China, Hanke explains.
"From the early 1970s until 1995, Japan was an enemy," he says. "The mercantilists in Washington asserted that unfair Japanese trading practices caused the U.S. trade deficit and that..[it].. could be reduced if the yen appreciated against the dollar — a weak dollar policy."
The Yen rose from 360 to the US dollar when the Bretton Woods system collapsed to 80 in 1995. In April 1995 then US Secretary of Treasury Robert Rubin had changed tack, as Japanese economic troubles worsened.
"In consequence, the U.S. stopped arm-twisting the Japanese government about the value of the yen and Secretary Rubin began to evoke his now-famous strong-dollar mantra," Hanke said.
"But, while this policy switch was welcomed, it was too late."
Many Japanese companies set up production bases outside Japan and started exporting from those countries which, analysts say is partly due to the appreciating yen and also due to lack of in-migration of labour as the population aged.
When Chinese imports to the US picked up, Hanke says its currency replaced the Japanese yen "as the mercantilists’ whipping boy."
But the relative strength of exchange rates fail to explain the US trade deficit. In China’s case the trade deficit rose while the Yuan appreciated.
While the Japan-US trade deficit declined over the last twenty ears, the relationship between Yen’s strength and the Japanese contribution to the total US trade deficit was weak says.
"After all, this exchange-rate argument (read: competitive advantage) is what the mercantilists use to wage war," Hanke says.
"And as for China, the relationship between the strength of the yuan and China’s contribution to the U.S. trade deficit contradicts the mercantilist conjecture.
"Indeed, the Chinese yuan has appreciated in nominal terms relative to the greenback over the past twenty years, and so has the Chinese contribution to the U.S. trade deficit."
In May 2015 the trade deficit with China hit 35.9 billion dollars urged to $51.4 billion in March, up sharply from $35.9 billion in February.
In the US Mercantilist arguments about trade deficits are not just peddled by politicians but also by economists like C. Fred Bergsten of the Peterson Institute for International Economics and supply side guru Arthur B Laffer Hanke says.
"The United States has recorded a trade deficit in each year since 1975. This is not surprising because savings in the U.S. have been less than investment," Hanke explains.
"The trade deficit can be reduced by some combination of lower government consumption, lower private consumption or lower private domestic investment. But, you wouldn’t know it from listening to the rhetoric coming out of Washington.
"This is unfortunate. A reduction of the trade deficit should not even be a primary objective of federal policy. Never mind. Washington seems to thrive on counter-productive trade and currency wars that damage both the U.S. and its trading partners."
"In short, the U.S. trade deficit is the result of a U.S. savings deficiency, not exchange rates."
Ever appreciating currency can also harm the country concerned. Hanke says volatility in terms of economic growth and inflation has deteriorated in China since it abandoned the fixed peg.
US had engaged in similar tactics in the 1930s, when China was under a silver standard, buying up dollars to push up its price, Hanke has said earlier. China was forced to abandon the silver standard amid chaos which also helped bring communists to power, he said.
Recent data also shows that money supply growth is slumping in China, which Hanke warns shows a deeper problems in the economy, pointing to slower growth ahead.
In the wake of the 2009 global downturn China also engaged in a massive stimulus, pushing excess reserves out and creating credit, an action that is fraught with danger, some analysts say.
Meanwhile says by allowing the Yuan to fall this month, Beijing seems to have abandoned the policy of the ever-appreciating Yuan. Beijing would be better served by adopting a currency board, he says like Hong Kong.
Hong Kong has a true fixed exchange rate or currency board since 1983.
"What should China do? First, Beijing should stop listening to Washington. Second, it should adopt a free-market, exchange-rate regime – like the currency board system in Hong Kong," Hanke says.
"Since 1983, the HKD/USD exchange rate has been fixed at 7.8, and the Hong Kong dollar has been fully convertible and fully backed by U.S. dollar reserves. By adopting such a fixed-rate regime, Beijing would dump instability and embrace stability."
A currency board would also make difficult for Mercantilists to make false claims that the Yuan is ‘manipulated’ or ‘undervalued’.
The move will prevent China from getting ‘whipped around’ by Washington and the International Monetary Fund, Hanke said in an interview with the BBC last week.
The Yuan fell when allowed to float this month rather than rising when controls were reduced.
But China has been so shocked by the frenzied reaction to the Yuan fall and the blame that it may get for any global economic instability, that it had abandoned plans to allow the currency to ‘float’ any further, media reports said.
The Yuan has only fallen 2.96 percent so far this year, compared to 5.4 percent for the Singapore dollar, 6.2 percent for the Korean won, 8.2 percent for the Thai Bhat, 16.7 percent for the Malaysian Ringgit.