Article

Prospects for China’s Currency Revaluation

 

 

 

A little over six months ago, a friend called me up with a "surefire" money-making investment: put money on China allowing its currency, the yuan, to appreciate within the next eight months. My friend was not alone; many investors and analysts believed at the time that a revaluation sometime in the fall was likely given China’s red-hot economy that a higher-value yuan would help cool down. Merrill Lynch, for example, forecast in April that China would allow the yuan to appreciate by 10 percent by the end of the year.

That expectation, however, has proven to be premature. China has not revalued its currency and looks unlikely to do so any time soon. Its unprecedented presence at the G7 meeting earlier this month was one illustration of how important the currency issue has become to major economies, which are pushing for China to revalue as soon as possible.

Given the strength of China’s economy, analysts estimate the yuan is undervalued by anywhere from 10 to 40 percent against the dollar. This imbalance has moved to the forefront of international economic policy efforts, and is particularly magnified by the increasingly worrisome U.S. trade deficit, which now looms at $600 billion. U.S. trade with China makes up about one-fourth of this deficit. The United States argues that by keeping the yuan’s value artificially low relative to the dollar, Chinese exports are unfairly cheap for U.S. consumers to buy and that U.S. exports to China are more expensive, fueling a worsening trade deficit and destabilizing the U.S. economy.

The economic arguments for China to revalue its currency in its own self-interest were compelling earlier this year. In the first quarter, its economy grew rapidly at a rate of 9.8 percent per year with inflation nudging up above an uncomfortable 5 percent. Chinese officials at the time were worried about the overheating economy; an appreciation of the yuan would have made China’s exports more expensive in foreign markets, lowering demand for them, reducing Chinese export sales, and helping to slow the economy.

For these reasons, investors and analysts believed China would revalue relatively soon, even though the country’s officials never provided a timeline for such a policy shift. But as oil prices have risen dramatically over the last several months, the forecasts for China’s economic growth over the next year have fallen to around 7.5 to 8 percent. Investment, which was the primary driver of China’s overheating economy, seems to have slowed, responding to the Chinese government’s controls over investments in certain key sectors. While inflation is still a concern and the economy continues to grow smartly, there is less reason than before for the government to consider using an appreciation of the yuan to help slow its economy.

Earlier this year, U.S. Treasury Secretary John Snow met with Chinese officials in Beijing and pressed them to allow the yuan to "float"— to allow its value to be determined in the markets. However, most analysts believe that a move to floating the yuan would be premature given China’s relatively weak banking system, which needs to be strengthened before such a change would be prudent. A revaluation of the yuan in the form of a one-step appreciation earns wider consensus as a policy move that would help stabilize imbalances in the U.S. trade deficit without exposing China’s banking system to unnecessary risks.

The diminishing chances that China’s overheating economy will necessitate a revaluation of the yuan leave the major economies with few options other than to return to a political appeal for a change in China’s currency policy. That is exactly what the invitation to the G7 meeting was, during which the major industrialized economies tried to convince China to move faster toward a more flexible exchange rate regime.

The meeting, however, produced no additional commitment on China’s part to specify when it might consider revaluing the yuan. China has simply indicated that its primary concern is ensuring that its relatively weak banking system is able to handle such a policy shift and maintained its earlier position that it would work toward an increasingly flexible exchange rate regime, with little indication of when or how. This strategy is actually quite smart if China is to maximize its control over the yuan’s value; the minute China indicates any sort of timeline for revaluation, foreign money will flow into the country, putting upward pressure on the yuan’s value and potentially forcing China to revalue or float sooner than it is prepared to do so.

There are few remaining options for the U.S. and China’s other trading partners who would like to see a rise in the value of the yuan. The only alternative by which the United States could attempt to force China to revalue its currency would be to bring charges against it through the World Trade Organization for unfair trading practices.

China surely understands that its economic success is increasingly tied to that of its trading partners and the world economy as a whole. To that extent, Chinese banking reform should be a priority as the first step in eventually enabling as fast and secure a shift as possible to a more flexible exchange rate regime.

Radha Chaurushiya is economic policy analyst at the Center for American Progress.

 

 

 

You Might Also Like