Trade wars and currencies

The USA thinks the answer to the huge imbalance in world trade between China and the rest is a revaluation of the Chinese currency, the renminbi.

China has responded strongly to this advice, telling the USA not to meddle in what China regards as her business. Premier Wen advises the USA to look to itself to sort out why it imports too much and exports too little. He managed a good side swipe at the hapless US President, by reminding the world that the uSA refuses to export some of her hi tec wizardry to China, items which China would like to buy.

The renminbi is a managed currency. There are tight restrictions on who can buy it and how much they can buy. It is not the official currency of either Macau or Hong Kong, relatively more exposed parts of the Chinese economy to world finance and trade. As Premier Wen explained, policy is to “keep the yuan (the highest unit of the renminbi currency) basically stable at a reasonable level”. The managed rate will only be changed if it suits China to change it. At the moment they think it adds to world recovery, as it enables China to grow rapidly.

There are two important questions for analysts to ask.The first is, could external events and US pressure lead to such a revaluation? The second is, might China wish to revalue the renminbi any time soon for her own reasons?

It is extremely unlikely that China will give way so soon after making a clear statement she has no intention of doing so. That would entail loss of face. China is also all too conscious that she owns large sums in dollar based investments, so any revaluation of the yuan immediately leads to a substantial loss on her holdings, as well as making it a bit tougher to export. The main thing she wants from the US – the cancellation of weapons exports to Taiwan – is unlikely to be conceded by the President, as that would entail too big a loss of face for him. US diplomacy is counter productive, delaying a revaluation which might other wise occur.

For there are domestic reasons which might lead to a revaluation. China has a growing inflation problem. The rate rose to 2.7% in February, and could rise a lot higher this year, following the explosive injeciton of credit and spending over the last year. China has started to rein in by ordering more bank reserves. She can do more of the same. A revaluation would also help cool the domestic economy, whilst cutting the prices of imports and helping a little with the inflationary pressures. She has not yet raised interest rates, fearing that could abort the recovery in a world where other economies are still struggling.

A revaluation of the renminbi is possible, but is not an immediate probability. The US could delay it further by overdoing the pressure on China. The USA does not have a very strong hand. The outside risk is the USA for internal political reasons overdoes the posturing against China and embarks on a course of tariffs or other restraints on trade. A more likely outcome is delay, followed by the inevitable revaluation of a strong currency for a country which remains super competitive at these exchange rates.

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15 Comments

  1. Posted March 16, 2010 at 9:51 am | Permalink

    I think the USA should follow the suggestion of looking into the reasons why they import too much and export too little, and the UK should also do likewise.

    We have become unproductive due to excessive state nannying, too much welfare, red tape and health and safety, funded by too much taxation leading to business flight.

    It can't go on like this.

    • Posted March 16, 2010 at 10:52 pm | Permalink

      And we have only been able to afford this profligacy by borrowing from China's surplus which in turn was made possible by an artificial exchange rate.

  2. Posted March 16, 2010 at 10:21 am | Permalink

    This is an issue Western politicians have been asleep on, China has been allowed to hollow out our economies by setting themselves an advantageous exchange rate.

    One of the reasons for the recession was this, in that China was allowed to circumvent the balancing factors in the world economy by fixing their exchange rate, so that there was no means to equalise out trade deficits.

    It was wrong to have allowed China to enter the globalised economy and to cherry pick the things it wanted, trade but without a compensating floating exchange rate. You might have thought we would have learnt our lesson from history, like the Opium wars, which came about because China would only accept bullion for their tea, and we were rapidly being impoverished as a result, until we found a commodity the Chinese would buy , opium.

    I would suggest there is something Western countries can do, put an import tax on Chinese goods to remove the exchange rate advantage they have created by undervaluing their currency.

  3. Posted March 16, 2010 at 11:05 am | Permalink

    There are comparisons to be made between China and Germany. Both produce more than they are willing to consume. They export their extra production and receive in exchange money, which in essence is a promise to provide goods. So they end up with a lot of money that they do not wish to spend.

    Such a policy makes some sense for an individual, who might be saving for retirement, or just to spend at a more convenient time. But countries don't retire, so there is no point in saving for that, and as for waiting to spend at a more convenient time, you have to ask why it is more convenient for them to buy things in the future rather than now.

    Because Germany is in the eurozone, and exports to other countries in the zone, this imbalance causes problems for the euro. At present Germany demands that the other countries spend less to overcome these problems, but the problems could more smoothly be overcome if Germany spent more, buying things from other eurozone countries.

    Similarly the USA would like China to buy more American goods. That is what is meant by asking for a revaluation of renmimbi.

    Both China's and Germany's policies are irrational, seen from the UK perspective. We always want to spend now even if it means borrowing from the future. We don't understand why they wish to defer pleasures that they could have right away. But I imagine that from their point of view they are establishing a powerful position in the world (China) or safeguarding against an uncertain future (Germany), both of which are rational policies even if they cause difficulties for others, and will one day cause difficulties for themselves as the resentment of others rises.

    By keeping sterling (a policy with which I disagree) we have given ourselves more freedom to borrow from the future, since we will repay in the future in devalued pounds. This deception works well only within the UK: we do not notice the fall in the value of our salaries and pensions since we are paid in sterling and make payments in sterling. But foreigners will notice that our currency declines in value compared to their own, and they are likely to become less willing to lend. Whether that will have serious consequences on our ability to borrow, we have to wait and see, but past experience is that we can get away with it.

    China and Germany gain power and influence now at the expense of resentment in the future; we gain more goods and services now at the expense of less in the future. We are all hoping that something will turn up to avoid the future problems, and maybe it will.

  4. Posted March 16, 2010 at 11:20 am | Permalink

    I would have thought that managing the Remimbi will cost them foreign exchange. No matter how much of that they hold in USD and Euro's it will evaporate like snow in springtime if the markets continue to apply pressure to them. Anyway, if the West is as indebted as we all know it is sooner or later we woun't have the money to spend on Chinese exports. Plus the inflation numbers reflect what has already happened – an explosion in the doemstic Chinese money supply. If they want to constrain prices it will cost them more USD as they fight to import commodities and subsidise them to their population. I agree Obama is useless, I always thought he was just a Black Blair – all pee and wind. But all he has to do is to constrain his own spending plans and sit it out.

    The one thing about Obama that is absolutely fantastic is that for the US to elect him shows just how liberal (in the UK meaning of the word) and democratic they are. It's one in the eye for all the absolutionist terrorists out there.

  5. Posted March 16, 2010 at 11:46 am | Permalink

    By 'managing' her currency China is in effect imposing blanket protectionism. I'd be interested to hear your views Mr R. on the USA balancing this protectionism with import tarrifs.

  6. Posted March 16, 2010 at 2:14 pm | Permalink

    I think that this is one of your weaker pieces in a long time John.

    The Chinese currency undeniably is artificially low and the price China has to pay is the effective devaluation of their US paper holdings. The Chinese point that US export performance is weak is entirely valid. Given the Chinese disregard for intellectuall property though I don't blame the US for holding back some of the High Tech stuff

    You only touch obliquely on the asset bubble that is developing in China. That is problematic as is domestic inflation.

    As always in China any threat to internal security will always trump any economic argument.

    Obama "hapless", possibly at the moment, but if he can get healthcare off the agenda by the end of 2010, get out of Iraq within 18 months and see the US economy start to improve next year he'll be hard to defeat in 2012. He will be helped by the extraordinary lack of leadership in the Republicans. In that regard the US is similar to UK, Conservative leadership of quality is an all too rare commodity- yourself excepted!

    I would never write off the USA because they have the enormous advantage of not being dominated by the dead hand of government the way UK is. When they recover they will do far better than UK.

  7. Posted March 16, 2010 at 2:28 pm | Permalink

    The question is might this be the elephant or the gorilla in the room of the world economy or even both? Being China I would not be surprised to find a bad tempered dragon there as well.

  8. Posted March 16, 2010 at 3:40 pm | Permalink

    If western countries focussed more on being competitive with the Chinese from standpoints other than exchange rates, then the world would be a happier and more productive place. The simple fact is that compared with developing countries we coddled westerners pay ourselves far too much, expect far too many social benefits, insist on excessive holidays, and generally wrap ourselves up in vast masses of red tape. How can we ever hope to compete with the likes of China, India, Brazil, never mind Thailand, Malaysia and Vietnam, when we seem to believe that we are so superior? The answer to all the current problems supposedly caused by global imbalances lies in the west improving its unit productivity, not in trashing the dollar and pound, or trying to force the Chinese into an undesirable revaluation. We need to pay ourselves less, expect less from the state, work harder and smarter, and shed the senseless regulations that destroy our competitiveness. Expecting exchange rates to compensate for our foolishness will never work – look at the evidence, the pound has been in the dumps for almost 2 years, and where is the export-led recovery? People living in the last century (like Mervyn King and Gordon Clown's former economic advisor Roger Bootle) will assure us that it's coming, or else that it's late because British managers prefer to bank the margin rather than invest it, or that British managers prefer to spend time on the golf course when the currency is undervalued, rather than looking for new opportunities. It's always somebody else's fault, never the fact that they are using an outdated and defunct model and are in fact simply economic dinosaurs themselves. God help us that such cretins are running our economic policies. If Clown is re-elected and King is allowed to stay on at the BoE, then the British economy shall look like it was wiped out by a meteorite and we shall go the way of the thunder lizards.

  9. Posted March 16, 2010 at 3:49 pm | Permalink

    Just imagine if our tariff policy were to make all imports duty free with two exceptions:
    (1) Where the article was produced in a non-environmentally friendly manner.
    (2) Where the article was produced in a country that was not operating a freely floating currency in the exchange markets.

    The idea would be to pitch the level of import duty at exactly the right level to counteract the offence, no more no less.

  10. Posted March 16, 2010 at 5:34 pm | Permalink

    It has also been reported that the Chinese are securing production of rare elements for themselves (especially in Africa), This is something that the free world needs to waken up to. I suspect China will revalue when it reckons that cheaper (US$priced) raw materials are in its' interests.

  11. Posted March 16, 2010 at 5:49 pm | Permalink

    Either China revalues or the US sticks trade tariffs on Chinese goods. The US is only growing because the Fed printed trillions of dollars, that has now been stopped so there is a good chance the US will double dip.

    Why would the US allow China to steal jobs by artificially keeping down the Yuan? the Us has China by the short and curlies, it can quite easily create capital controls meaning China loses control over its trillion dollar savings…….

  12. Posted March 17, 2010 at 12:31 am | Permalink

    china like india competes with us by running similar plants with total disregard for anti pollution measures and health and saftey standards which would be compulsory in europe

    i strongly suggest we could wipe the floor with much of the so called competition from china if our best folk were allowed to run a few factories operating to similar pollution standards as their equivalents in china

    China like India also steals our IP regularly, if I was a leader of the USA or Europe I would tell the leaders of China and India to stop raping our Industry in this and other ways

    plus of course the cheap labour abused with much bullying and so on

    sort some of these issues out and the performance of china would be exposed more realistically

    put in this context of some of this the performance of europe and the USA isnt as bad as it seems looking at the raw numbers

    anyways talk in the pub today was of the price of petrol at the pumps, wonder what the conservative party is on that issue?

  13. Posted March 17, 2010 at 9:56 am | Permalink

    It would seem there is a general consensus to what is the problem , and the solution.

    Shame our politicians are so incapable of fighting our corner and are content to sit on their backsides while our industrial base is hollowed out by the likes of China. Perhaps the biggest problem is to be found in Westminster.

  14. Posted March 17, 2010 at 10:45 am | Permalink

    It is all a bit muddled. China are stealing value from their own consumers and giving it to the Americans and this is considered by the Americans as a bad deal.

    A five dollar pair of Jeans might cost seven dollars after a revaluation and would deliver an extra two dollars to the Chinese economy (albeit the same number of remimbi).

    Instead they continue to charge five dollars and accept payment in the form of paper printed by the Fed, notionally at near zero cost.

    The Chinese are beating up their own people by not revaluing whilst the Americans are beating up their own people by continuing to suffocate their own economy with fiscal stimulus and blaming the Chinese for swamping them with cheap imports.

    America must allow their economy to rebalance so that their industrial base can again grow strongly and provide export led strength which can only be done if their government reduces spending dramatically.

    The Chinese can then be left to continue to beat up their own people whilst the Americans can enjoy the fruits of both a strong economy and cheap Chinese imports.

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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