China’s currency reforms may make ‘get tough’ promise moot

Presidential candidates of both parties like to score points with voters by promising to get tough with China, but recent evidence suggests that currency reforms quietly adopted by the Asian giant since 2005 have come close to eliminating the biggest trade distortion and bone of contention between the two countries.

U.S. leaders have complained for years that Beijing manipulates the value of its currency against the dollar to ensure low prices for Chinese imports and gain an advantage in trade over higher-priced American products. Partly because of such currency suppression over the years, China has taken over entire markets for consumer goods in the U.S., including Christmas ornaments and cribs, by underpricing competitors, causing the U.S. trade deficit with China to bloat to the largest in history, a record $295.5 billion in 2011.

President Obama, while celebrating recent progress on the currency issue under his administration, frequently says it is not enough and exhibits his political macho by targeting China for high-profile trade enforcement actions involving solar panels, wind turbines and other products.

Republican presidential nominee Mitt Romney has sought to one-up the president by taking the strongest stand of any candidate against China. He vows to crack down on its alleged currency manipulation as one of his first acts in office — a move that Chinese leaders have warned would provoke a monumental trade war between the world’s two largest economies.

Despite the rhetorical bombast, leading financial analysts say considerable progress already has occurred in realigning the currencies. Under pressure from the George W. Bush and Obama administrations, China since 2005 has allowed its currency to gain more than 30 percent in value against the dollar, and analysts say the Chinese yuan now appears to be close to a fair, market-determined value for the first time.

In fact, Moody's Analytics declared recently that the yuan’s rise may have gone too far and it may be slightly overvalued with respect to the dollar. Wall Street powerhouse Morgan Stanley says the realignment of currencies has gone so far that it is now causing considerable pain for Chinese exporters and will force them to start raising their prices on Chinese imports in a major way. That would be an important development that not only would make perennially cheap Chinese products a thing of the past in the U.S., but could significantly change the economic and political relationship between the two economic superpowers.

“When it comes to economic relations with China, U.S. political leaders are responding to the problems of yesterday rather than preparing for tomorrow,” said Samuel Sherraden, an analyst at the New America Foundation, contending that the currency fight is a thing of the past.

“Lawmakers in both parties — from Republican Mitt Romney to leading Democrats on Capitol Hill — continue to criticize China for its currency manipulation” but seem to be missing the fact that the currency is now fairly valued while other major economic problems have emerged in China that could have “dangerous spillover effects for the U.S.,” he said.

Specifically, China is experiencing a major economic slowdown this year — a principal reason its currency stopped appreciating against the dollar. Mr. Sherraden said the slowdown poses a substantial threat to U.S. growth because China had been America’s fastest-growing export market. Recent economic reports show a big pullback in U.S. manufacturing this spring, which appears to be reflecting a tanking of U.S. exports to China and the European Union.

Moreover, Mr. Sherraden said, there are signs that China’s slowdown could turn into a full-scale economic rout that would be devastating to the already stagnant U.S. economy. All the rhetoric focused on China’s currency just inflames nationalistic passions in Beijing, he said, and may be preventing China’s leaders from attending to the more pressing economic matters at home.

Currency fairly valued

A growing school of financial analysts agree that China’s currency is no longer undervalued and that economic growth is the bigger problem facing both countries.

“The market thinks the yuan is near fair value,” said Alaistair Chan, author of the Moody's analysis. Moody's and a few other forecasters estimate that the yuan actually has gained more than the 30 percent in nominal appreciation against the dollar seen since 2005. When the faster rate of inflation and wage growth in China are taken into account, it could be considered as much as 60 percent higher, they estimate.

The sea change in currency rates suggests that the pressure applied by U.S. administrations of both parties since the 1990s has been largely successful. Because of the economic weakness in China this year, global investors are no longer betting on the inexorable rise of the Chinese currency against the dollar, but rather now expect it to start depreciating modestly in value, Mr. Chan said.

The downward pressure on the yuan this year has been so strong that Chinese authorities even had to intervene to prop up its value by selling dollars this spring. That represents a complete reversal for the Chinese, who for more than a decade intervened strenuously to prop up the value of the dollar by selling yuan, to ensure China’s vast export sector remained competitive. China’s massive dollar purchases over the years are what led to its amassing an unprecedented store of dollar reserves worth $3.2 trillion at the end of last year.

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