The Right Atmosphere

A Chance for China to Demonstrate Leadership on Exchange Rate

China’s clout grows at the International Monetary Fund, putting the spotlight on Beijing to revalue the yuan as part of its global commitments, write Winny Chen, Sabina Dewan, and Nina Hachigian.

Zhu Min, pictured here at the World Economic Forum earlier this year, will become the right hand of IMF Managing Director Dominique Strauss-Kahn. (AP/Michel Euler)
Zhu Min, pictured here at the World Economic Forum earlier this year, will become the right hand of IMF Managing Director Dominique Strauss-Kahn. (AP/Michel Euler)

China today will place Zhu Min, a senior Peoples’ Bank of China official, at the right hand of International Monetary Fund Managing Director Dominique Strauss-Kahn at a time when China’s voting strength at the IMF also is set to increase. China’s increasingly important role at the IMF and World Bank, which also boosted China’s voting clout earlier this year, may well be behind persistent reports that China’s leadership is preparing to announce the gradual appreciation of the yuan as part of its growing responsibility for the stability of the international economy.

If this happens, then it would demonstrate that the U.S. Treasury Department’s decision last month to postpone its report to Congress on international exchange rates, including China’s yuan, was the right thing to do. Not only did the decision give the U.S.-China relationship a chance to get back on track after recent tensions. The postponement also gave the Chinese time to make a responsible decision with global implications—and would give the Obama administration another notch in the diplomatic win column after a rough start with China in 2010

U.S.-China relations first hit a hard patch in late 2009 following an unusually smooth incoming year of an American president. Whether due to the global financial crisis, savvy advisors, or both, the Obama administration broke from the usual script of scapegoating China in the election cycle and veering back to reconciliation once in office. Most of 2009 was a positive, stable year for U.S.-China relations, with results to show on bilateral military relations, the environment, and both countries instituting significant fiscal stimulus packages to bring their economies back on track and to restart the global economic engine.

But interests are interests, and eventually the thorny issues of trade, Taiwan and Tibet re-entered the picture. In September of 2009, the Obama administration announced that the United States would levy tariffs of up to 35 percent on tires from China. Then in the first month of 2010, President Barack Obama announced his intention to sell $6.4 billion in defensive arms to Taiwan. Not long after, President Obama met with the Dalai Lama at the White House—a move he had notified Chinese leaders of during his November trip to Beijing.

Beijing reacted with predictable and escalating outrage to all three U.S. decisions. And the news coverage U.S.-China relations was equally shrill, portraying the Obama administration in 2009 of kowtowing to Beijing—only to discover this year that the relationship was traversing a very serious “rocky patch.” But the bilateral relationship seems to have re-entered positive territory only a few weeks later, when President Obama met with the new Chinese Ambassador Zhang Yesui to discuss broader U.S.-China relations. Then came President Hu Jintao’s recent decision to attend President Obama’s nuclear summit in Washington this week, forming a trend line that is steadily pointing upwards.

The currency decision

Still, there is a key decision still to be made by Beijing on its exchange rate, which has been running steady at about 6.8 yuan to the dollar since the onset of the global financial crisis after China allowed its currency to appreciate beginning in 2005. (see chart)

Underappreciated: The yuan-dollar exchange rate

Though the Treasury Department’s decision to postpone its April 15 report to Congress on international exchange rates (including China’s yuan) disappointed a vocal constituency in the United States, delaying the decision was the right tactic. First, the decision kept China engaged on the nonproliferation agenda—President Hu Jintao attended the nuclear nonproliferation summit two weeks ago in Washington—while allowing more time for Chinese leaders to allow their currency to appreciate on their own terms for their own reasons.

Second, the bilateral relationship is not the best forum for the debate on China’s currency misalignment. History suggests that U.S. pressure is most effective when China feels globally isolated and when the results Washington wants become a question of China’s international legitimacy. Getting China to let its currency appreciate will require a coordinated effort among multilateral array of actors such as the IMF and the Group of 20 developed and developing nations.

Indeed, redistributing the voting shares (or quotas) in the International Monetary Fund to better reflect China’s weight as a member of the global economy, and simultaneously empowering the IMF to better monitor and report on exchange rate policies may help steer China toward more responsible behavior. China, of course, has worked to weaken the IMF’s authority to review member nations’ exchange rate policies, so this will be an ongoing contest. The IMF is expected to take up the new quota vote later this year.

Finally, the G-20 process offers another constructive forum in which to address China’s currency valuation. The group, in which China has an equal say and where many countries are likely to agree with the U.S. position on China’s undervalued currency, puts China’s reputation as a responsible leader on public display. In the lead up to the G-20’s November meeting, or even sooner, China may well decide to take some of the heat off and continue to loosen its monetary policy, much as it made some surprising promises in the lead up to the international conference on global warming in Copenhagen this past December.

But as leading economists consistently remind us, China’s currency is only a small part of the equation when it comes to the U.S.-China economic relationship. China’s misaligned currency is but one small part of a larger imbalanced Chinese economy—the result of other monetary, industrial, and social policies, such as excessively low interest rates, wage constraints, and a high disparity between savings and lending. Meanwhile, the United States certainly has some way to go to address its own long-term economic health.

Of course, it is possible that these multilateral approaches may not work. China might not let the renminbi appreciate significantly, let alone trade freely in international currency markets. If so, then there is always plan B—designate China a currency manipulator and see whether that has any greater effect. But to use that strategy now, as CAP’s Scott Lilly argues, would have simply been a mistake.

Encouraging China to become a responsible steward of the international system is going to be a long and potentially frustrating process, and it may not always be possible to choose the politically expedient option. But a little patience now may be a good investment for our economic future and for the global economy.

For more information, see:

Nina Hachigian is a Senior Fellow at the Center for American Progress who focuses on great power relationships, international institutions, the U.S.-China relationship, and U.S. foreign policy. Sabina Dewan is Associate Director of International Economic Policy at the Center. And Winny Chen is a policy analyst and Manager of China Studies at the Center. For more information on these issues, please see the Global Economy page of our website.

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Sabina Dewan

Senior Fellow

Nina Hachigian

Senior Fellow