The Hindu Business Line : America's war on the yuan

Hawks in the US were expecting the latest bi-annual `Report to Congress on International Economic and Foreign Exchange Rate Policies' released by the US Treasury to brand China as a "currency manipulator." K. SUBRAMANIAN looks at the circumstances leading to the Treasury's stand.

America's war on the Chinese yuan or, rather, over its exchange rate, has been raging for quite some time now. What started as a bilateral issue around 2001 is enmeshed in a contentious debate over global financial imbalances. There are as many interpretations of financial imbalances as there are economists. Prof Barry Eichengreen described them "As the blind men and the elephant." Sadly, the growing uneasiness over global imbalances has divided the G-7 and diminished its role.

Precipitate action feared

The changes in global economic balance influence policymakers in the US Treasury. They are aware that they do not have the same freedom now as in earlier eras. There is fear of precipitate action endangering the financial system. The latest bi-annual Report to Congress on International Economic and Foreign Exchange Rate Policies released by US Treasury on May 10 reveals this angst.

Hawks in the US expected the Report to brand China as a "currency manipulator." Mr Morris Goldstein, an old IMF hand, said: "I think the report is a disappointment and a step backward." However, Prof Nouriel Roubini explained (www. rgemonitor.com/blog/roubini/12168 of May 10, 2006) why the Treasury did not utter the dirty M (Manipulation) word. It is interesting to study the circumstances leading to the Treasury's stand.

Pressure tactics

The yuan war commenced in 2001 and, ever since, China has remained implacable and unyielding to American and G-7 pressures. At all occasions and meetings, China has maintained that while it is committed to moving towards "a flexible, market-based foreign exchange rate," it would do so at a time of its own choice and would not take any decision under duress. In fairness, it did elaborate on the intractable problems facing its banking and financial sectors and how it cannot reform the exchange rate upfront.

The US Treasury issued a warning in its Currency Report of May 19, 2005, that unless China reformed its exchange rate, it would be liable for punitive steps. The last straw was the Bill tabled by Senators Charles Schumer and Lindsey Graham seeking to impose a 27.5 per cent tariff on all Chinese goods.

On July 21, 2005, in a surprise move, the People's Bank of China (the country's central bank) set the value of the yuan against a basket of currencies, moving away from dollar peg. The yuan was re-valued by 2.1 per cent with an assurance that it would be adjusted in future as a "managed float" with changes "when necessary, according to market development as well as economic and financial situation." It was a deft move and has blunted much of the criticism since. The Treasury was happy and informed Congress that China was on the mend. The Schumer-Graham Bill was deferred. However, the reprieve was short lived.

Since then, the irony is that the US Treasury is caught between the continuing demands of US groups and the glacial pace of Chinese reforms. With the publication of successive rounds of data revealing burgeoning US deficits and Chinese surpluses, tension mounts and leads to more demands on China.

IMF's role

In time, the US Government began to involve multilateral agencies for succour. With its closeness to the IMF, the US Treasury expected to rope in the Fund easily. The Fund was also looking for a new focus on its operations, as it feared marginalisation with the premature of exit of its former debtor clients.

When the IMF managing director, Mr Rodrigo de Rato, attempted a strategic review of the Fund's activities in September 2005, the Treasury hitched the yuan war to the IMF wagon. Mr Tim Adams, Under-Secretary, demanded that the Fund should be "far more ambitious in its surveillance of exchange rates" and its most fundamental responsibility was exchange rate surveillance, that is, policing China. Mr Rato disagreed openly and refuted the charge that China was violating IMF rules against currency manipulation. He referred to the Treasury's earlier currency reports and alleged that it was changing its position for political reasons.

Notwithstanding the Fund's reluctance in the first round, the hand of the US Treasury was visible in the new surveillance system unveiled by the Managing Director in the spring meetings of the IMF in April. Mr Rato envisaged a proactive role to address global imbalances and to conduct "specific consultations with specific governments, not in a bilateral process but in a multilateral one." It will zero in on "relationships, linkages, spillovers" between one country's policies and the rest of the global financial system. Though China was not named, it was clear how the system would work.

It is a futile exercise and there is no hope that the new role for the IMF would be approved at the annual meetings in September. As Mr Morris Goldstein put it, it was no more than "Window dressing and inaction" which would not "advance the grand bargain." (Financial Times, April 21, 2006.)

Without radical change in ownership and governance (or seats and shares), as proposed by Mr Mervyn King, Governor, Bank of England, the IMF would lack legitimacy. As The Economist explained, "On the world's most intractable macroeconomic challenge, unwinding the imbalances between excessive borrowing in America and excess saving elsewhere, the IMF has no clout."

Mr Zhou Xiaochuan, Governor, People's Bank of China, held that the Fund surveillance should comply with the objective of promoting exchange and financial stability and "respect the autonomy as to exchange rate systems that is granted to all (IMF) member countries." Other developing countries also expressed serious reservations. The cohesion among them should have dismayed the US, suggesting that the confrontation was no longer between the US and China, but between the US and Asia.

US uncommitted

On its part, the US was unwilling to commit itself to any reduction in its fiscal deficit even as it exerted undue pressure on the emerging countries to revalue their currencies. The mood was grimmer in the governors' seminar on global payments imbalances at the annual meeting of the Asian Development Bank held in Hyderabad early in May.

As Mr Martin Wolf narrated, "The discussion made even clearer than before how far the irresistible force of US desire for exchange-rate movement... meets the immoveable object of Asian resistance... .As a result... the chances of a row even worse than the one accompanying the end of the Bretton Woods exchange rate systemin the early 1970s grow even bigger" (Financial Times, May 9, 2006).

Mr Timothy Adams, Treasury Under-Secretary, would have taken home the message. The currency Report was issued on May 10 and it is no surprise that it did not pander to the hawks and fuel protectionist forces.

Mr Stephen Roach of Morgan Stanley views it is "a principled stand." There may be other reasons. The Treasury had to take note of several steps taken by China to realign its exchange rate system, improve its financial structure, raise domestic consumption, and so on.

Further, the global financial system is on a precipice and any precipitate step could move the Chinese (and Asian reserves) away from the US to other locations/assets, creating a financial turmoil. The Chinese have been holding out this threat since November 2005 and are known to have diverted large amounts. In the US, there are the likes of Prof Roubini, who feel that multilateral surveillance through the IMF would be a better option and should be pursued.

There is also hope that the United States Trade Enhancement Act of 2006 introduced by Senators Grassley and Baucus would be passed soon. This Act is expected to transform the Currency Report by involving IMF research staff in its preparation. These are vain hopes. If recent developments are any indication, it may no longer be practicable to resolve financial issues without global negotiations involving all the stakeholders. Is the US prepared?

(The author, a former Finance Ministry official, has experience in international, financial and trade issues.)