The Hindu Business Line : Undervaluing yuan will not help US' cause

The US economy is giving off quite a few negative signals — a huge current account deficit of around 6.6 per cent of GDP; consumer price index up to 3.3 per cent; the Federal Reserve raising interest rates; unemployment at a relatively high 4.4 per cent; and; the dollar depreciating against the euro.

American policy-makers view china's undervalued yuan as the main cause of the US current account deficit. The US current account deficit implies that its magnitude of imports is higher than exports, emasculating the country's lacking in export competence. American Senators Charles Schumer and Lindsay Graham have proposed a 27.5 per cent across-the-board tariff on all Chinese imports until China revalues the yuan. They believe that an undervalued yuan, together with government subsidies, underpins sustained Chinese exports.

China's high saving rate is a major contributor to the country's large global trade surplus. The country's reforms over the past three decades in health-care, education, housing and other social sectors resulted in high saving rates. This, in turn, led to a significant portion of its income being generated by exports, driving up China's trade surplus with the US and the latter's trade deficit with the former.

To some extent, the credit goes to the dynamics of globalisation for China's export momentum. Multinational corporations make investment and purchase decisions based on profit margins; on these scores it is advantage China, the favoured global manufacturing hub thanks to its low labour cost.

At the global level, counter-balancing the US's deficit is the combined surplus of the oil-exporting economies. The latter are expected to run a total current account surplus of around $500 billion this year, while China's will be plus $200 billion. The crude oil economies of West Asia still peg their currencies to the dollar, partly in preparation for the plan to adopt a single currency by 2010, and partly because oil is priced in dollar and they want to avoid exchange rate risk.So, the US should worry more about fixed exchange rate of the West Asian currencies than the gently rising Chinese yuan.

In the last two decades the US Government has used expansionary monetary and fiscal policies to promote growth. One result of this policy is the low interest rate that has fuelled the property boom and lulled people into thinking that there is no need to save. Monetary expansion increased liquidity in the market. Low interest rates and availability of loans sparked huge investment. This resulted in poor savings, which, in turn, increased the gap between savings and investments. These factors contributed to a huge current account deficit in the US. More investments in the US were an incentive to manufacture capital-intensive products. At the same time, technical progress also induced traditional industries to shift to capital-intensive products that led to job loss and decline in wages.

Washington used expansionary monetary and fiscal policies to promote the growth. But the purchasing power created was siphoned out of the economy to pay for crude oil.Rising crude oil prices resulted in surpluses of oil-exporting economies. According The Economist (December 9, 2006), West Asian economies are running an average current account surplus of 30 per cent of their GDP, well in excess of China's surplus of 8 per cent.

A rise in Yuan would not be a cure by itself for the US's deficit. The main solution is for Americans to save more. There is need also to shift production towards exports. The domestic demand also needs to be reduced, perhaps by cutting the fiscal deficit or tightening the monetary policy. Ultimately, the US will have to reduce its consumption, preferably voluntarily or circumstances will force it to do so.

(The author is Assistant Professor of International Business, Institute of Management, Nirma University, Ahmedabad. E-mail: Deepak@nim.ac.in)