Weak renminbi is both boon and bane for the US

By Christopher Swann Economics Correspondent
Financial Times; Jul 26, 2003

When unfair currency manipulation by other states has become a bone of contention in the US, the finger has generally been pointed at Japan.

Recently, however, US manufacturers and the government appear to have turned their attention to China. Last week, John Snow, the US Treasury secretary, appeared to give his blessing to Japanese intervention in the markets to prevent a rise in the yen against the dollar. But there has been no let up in the quiet campaign to cajole China into revaluing its currency, which has been pegged to the dollar for almost a decade.

The reason is not hard to see. While the Japanese bilateral trade surplus with the US has tailed off since 2000, China's has exploded. The US bilateral trade deficit with China ballooned to $100bn last year. Chinese exports doubled between 1997 and 2002.

But the case for a revaluation of the renminbi is less clear than many assume.

The bumper Chinese trade surplus with the US has in part simply been transfered from other Asian countries. The United Nations has estimated that China's average wage is 20 per cent of that in Malaysia and Taiwan and 10 per cent of that in Singapore.

As a result, other Asian countries have been sending many of their goods to China for completion before being shipped to the US. This role as the last port of call for many Asian exports has also made China the whipping boy of the continent.

About 50 per cent of China's exports come from multinational companies, many of them based in the US.

In addition, China can scarcely be considered a menace to the US in other export markets, since the emerging Asian giant specialises in goods that the US has not produced in 40 years.

Since the Chinese are unlikely to revalue out of a sense of altruism, the issue will be decided on purely domestic grounds. Here there is no over-riding reason for anything more than a modest adjustment.

The main problem the trade surplus is causing the country is rapid growth in its money supply. The Chinese central bank has been converting most of the country's balance of payments surplus into local currency in order to prevent the renminbi from rising against the dollar. The renminbi generated have then found their way into the banking system.

Normally this might be expected to fuel inflation. In China, which is close to deflation, the problem is slightly different. The extra cash has been fuelling a dramatic rise in loan growth and producing bubbles in some sectors of the economy.

Nevertheless, the Chinese authorities have recently been able to limit this problem by mopping up a large proportion of the extra liquidity.

Provided this problem can be contained, the gains of a weak renminbi are substantial for China.

China's competitive exchange rate has helped drive economic growth and create jobs. China needs to create 20m-25m jobs a year for the next decade in order to absorb people moving from villages to the cities and workers being made redundant from state-owned enterprises.

In fact if any country needs fast economic growth it is China.

Finally, the US should be careful what it wishes for. Purchases of dollars by the Japanese and Chinese central banks are likely to fund about 45 per cent of the US current account deficit in the second quarter of the year.

UBS estimates Japan has bought about $39bn and China $27bn - compared with an expected current account deficit of $147bn.

This has thrown a lifeline to the US. Not only have these inflows helped prevent a collapse in the dollar - which would almost certainly disrupt the fragile recovery in the equity market - they have also helped cap bond yields.

At a time when the rise in US yields has been undermining the policy of fiscal easing employed by the Fed, any reduction in demand for bonds from Asia would be bad news.