US Cant devalues renminbi debate

"Only connect" seems to be the favoured theme for US foreign policy hands, the connection in this instance being one with China. After all, no one wants another bipolar world, dominated, this time, by the US and China. What is more, North Korea's nuclear threat seems to be growing and Pyongyang listens only to Beijing. The State Department and even Pentagon types offer endless therapeutic talk about "locking China in", offering a friendly hand to China and so on. This week Richard Haass, former director of policy planning at the State Department, published The Opportunity, a book arguing that the US must choose between making China a partner or earning "the permanent enmity of 1.3bn Chinese".

There is irony here. While State and Defence speak soothingly about links, the Treasury is hacking away at the single most important link between the two countries - the monetary link.

China has said that its longstanding peg of Rmb8.3 to $1 will not last forever and that it supports more flexible rates in future. But for a US Treasury that lives in fear of an increasingly protectionist Congress, that is insufficient. The Treasury wants China to unpeg - yesterday. And there is nothing soothing about the way it is asking for that change.

John Snow, Treasury secretary, scolds the Chinese for maintaining a "rigid currency regime" that is "highly distortionary". China may be guilty of currency manipulation. In the Treasury view, the low Chinese currency is hurting US business. If China does not unpeg, the Treasury argues, then the mad dogs on Capitol Hill will pass new tariffs to keep out Chinese goods. To top things off, the Treasury is disingenuously deploying a free-trade argument - that the market, not governments, should determine a currency value - to get what it hopes will be a protectionist result.

Even those who are happy with the Treasury's behaviour will concede that there are three problems with its arguments. The first is that they are unworthy of the Treasury. The US is trying to manipulate the Chinese currency, yet it is accusing steadfast China of manipulation. The second is economic. Unpegging, especially hasty unpegging, will not necessarily help the US. And it could hurt the Chinese economy - badly. The third problem is, however, political. By humiliating China into giving up the one link it likes - on a US timetable to boot - the US is proving just as unreliable and arrogant as the Chinese always expected it to be. Consider the history. Back in the early 1990s, China was already expanding. But its unreliable currency and its primitive banking system limited future economic growth. The Chinese chose an interesting solution. Rather than overhaul their financial system, they lashed their currency to the dollar.

Small places,most notably nearby Hong Kong, had been pegging for a while. But for a large nation - one with nuclear weapons - a peg was not an obvious step. A potential superpower was ceding monetary sovereignty to an already existing superpower. The act represented the sort of demonstration of trust that the US State Department today longs to elicit.

There were serious costs to the peg arrangement. The peg allowed China to postpone creating a modern financial system, a problem that haunts the country today. But the certainty of a fixed exchange rate facilitated trade and Chinese growth. Because they knew that Chinese money was as good as the dollar, foreign investors poured in. Because the exchange rate was so low, Chinese exports were cheap. The Chinese regime was not democratic, but its monetary policy created jobs and improved the standard of living.

Without its peg, China could not have sustained such high growth. For the poor of China the growth rate serves as a promise that their own turn will come. For better or worse, the dollar behind the renminbi has become part of that promise.

The Treasury insists that unpegging will bring a healthy revaluation of the renminbi against the dollar. But even if that revaluation happens, China's Asian neighbours are ready to step in to provide equally cheap products. Unpegging may please US union lobbies. But it will not necessarily even cause the US current-account deficit to narrow.

For China, unpegging may cause enormous trouble. Most observers believe that when China unpegs, the Chinese currency will revalue against the dollar by something like 10 per cent. This, however, assumes that Chinese monetary authorities will be able to control a suddenly adjustable exchange rate, a questionable assumption in a country awash with hot money. The renminbi could move yet higher against the dollar. It could also jerk up only to plummet.

After all, China's banking system is, as mentioned, still definitely third world. And third-world systems do not handle currency ruction well. The disruption will, in turn, hurt jobs, savings and growth. China might face protracted economic pain. Chinese citizens might react in Latin American fashion, blaming everything on the US. Hardly a change that would make them trust the US on Taiwan or North Korea. All of which is not to say that China should never move towards convertability or alter its peg. What is important, rather, is that the Bush cabinet unify both tone of voice and position. The US wants more connection to China? Let it think twice about the way that it is ending the connection it already has.

© Copyright 2005 Financial Times

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