How China Manipulates Its Currency – And Why We Don’t Do It

President Obama and Gov. Romney agreed on at least one thing in Tuesday night’s debate: China cheats at international trade. Romney accused China of stealing our intellectual property. The president said China  flooded the U.S. market with cheap tires. Worst of all, China depresses the price of its exports by manipulating its currency. Now that currency manipulation a major buzz phrase in the presidential campaign, it requires the full Explainer treatment.

How does China manipulate its currency?

By buying U.S. government debt. In a free market, a trade surplus should increase the value of a country’s currency. People want to be paid in local money, creating demand for the currency, which in turn raises its value. Over time, this provides a counterweight against runaway trade imbalances. That process doesn’t happen in China, because the government constantly prints new currency and uses it to buy U.S. dollars and U.S. government debt, thereby flooding the market with Chinese currency and increasing demand for American dollars. As of this writing, China holds $1.15 trillion in U.S. government debt, and the country’s foreign exchange reserves are nearly as great as those of all advanced economies combined.

Advertisement

Until June 2010, the Chinese government dictated the value of the yuan against the U.S. dollar, a strategy known as “pegging.” China claim to have abandoned the pegging system, but the country still manages the value of the yuan within a narrow range. According to many estimates, Chinese government intervention keeps the yuan approximately 20 percent below its free market value against the dollar.

Is currency manipulation legal?

No. International law grants sovereigns the right to manage their currencies, but a country can limit those rights through international agreements. China’s membership in the IMF requires the government to “avoid manipulating exchange rates … in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.” The IMF agreement, however, is toothless. China claims that it manages its currency to ensure domestic stability, not to cheat trading partners, and there’s no venue in which anyone can effectively challenge that claim.

The WTO, unlike the IMF, has a dispute-resolution mechanism, but its rules don’t directly address currency manipulation. A WTO complaint would have to shoehorn China’s currency practices into an existing provision. The United States could argue, for example, that currency manipulation represents an illegal, market-wide export subsidy. Alternatively, the Obama administration could bring a so-called “non-violation complaint,” alleging that China has undermined the spirit of the WTO agreement through a loophole. These arguments, although plausible, would be unprecedented.

Dissatisfied with international enforcement options, Congress passed its own law in 2011 that requires the Treasury Department to publish semiannual reports on suspected currency manipulators. If the administration deems a country a currency manipulator, the president may impose tariffs against its imports to offset the effects of the depressed currency. Citing slow but steady appreciation of the yuan, the administration has repeatedly declined to apply the label to China.

Why don’t we retaliate against China’s currency manipulation?

Because of unintended consequences. It’s impossible to say what negotiations have taken place between the Obama administration and the Chinese government behind closed doors, but open retaliation for Chinese monetary policies would impact our own economy. Import tariffs on Chinese products or taxes on conversions between dollars and yuan would raise the prices of cheap Chinese products, which American consumers rely on. Advocates for retaliation, however, argue that the mere threat of sanctions would force China to change its policies. Skeptics also claim that multinational corporations have used their political influence to forestall U.S. retaliation. They have benefitted from cheap Chinese labor and a depressed yuan, the argument goes, and have no interest in changing the system.

Do other countries manipulate their currencies?

Yes. In 2010, the Japanese government moved to depress the value of the yen. South Korea also has a habit of intervening in the value of its currency. Switzerland pegged its franc to the euro beginning in 2011.

Observers insist that there are major differences between these countries and China. Switzerland’s move was defensive-terrified investors were buying up francs to get out of the euro in the depths of the European debt crisis. Japan and South Korea argue that the artificially cheap yuan forces them to manipulate their own currencies to remain competitive with China.

Other currency manipulators also tend to be more transparent than China. Switzerland publicly announced that it would not allow the franc to rise above 0.83 euros, and has stuck to that ceiling. China doesn’t say exactly what it currently pegs the yuan to, nor what valuation the country is willing to tolerate.

If currency manipulation is so great for exports, why don’t we try it?

Because it would eventually destroy our economy. The U.S. dollar is the world’s reserve currency, which benefits the American economy tremendously. American businesses can usually conduct international business without going through the trouble and expense of exchanging their dollars. Many people worry that the dollar is already losing this status, but manipulating its value would accelerate the process.

Competitive devaluation might also destabilize the global economy. Following the collapse of the gold standard, European countries engaged in several rounds of currency depression in a strategy now known as “beggar thy neighbor.” The uncertainty over the future value of currency eventually hobbled trade, and probably contributed to the rise of fascist leaders.

The U.S. government has knowingly taken actions that affect the value of the dollar on occasion. The Federal Reserve, for example, has printed money and bought trillions of dollars’ worth of mortgage-backed securities and treasury bills in a stimulus strategy known as quantitative easing. The move certainly depressed the value of the dollar, but the effects were relatively minor.

Source: SLATE – EXPLAINER

{Matzav.com Newscenter}