Bob Davis and Aaron Back, “IMF Sees Yuan as Undervalued”

IMF Sees Yuan as Undervalued, Wall Street Journal
Despite China’s decision to adopt a “flexible” exchange rate, the International Monetary Fund’s long-delayed review of the Chinese economy found that the yuan is “substantially undervalued,” according to IMF officials.

The IMF determination is bound to put pressure on Beijing to let the currency appreciate more than the 0.7% it has risen since China loosened the yuan’s peg to the dollar on June 19. The IMF determination was backed by the U.S., Germany, France, the United Kingdom, among others, say two individuals familiar with the deliberations, as the IMF’s executive board debated the China report on Monday, though none of the countries pushed China to boost its currency quickly.

In China, the central bank had been explaining to the public how a flexible exchange rate can help the economy by alleviating inflation pressures and improving the effectiveness of monetary policy.

On Monday, before the IMF’s board met, Hu Xiaolian, a respected deputy governor of the People’s Bank of China, made her third statement in less than two weeks addressing the reasons for the government’s decision last month to loosen the yuan’s de facto peg against the U.S. dollar, a change that was vocally opposed by Chinese exporters and some other interest groups.

Her comments echoed arguments made by IMF and other global institutions, but were unusual coming from a Chinese official. “This kind of openness is very rare,” said Ken Peng, an economist at Citigroup. “The tone of Hu’s statements has actually grown stronger as they have come out.”

It’s unclear whether the IMF’s determination will strengthen the hand of those in Beijing urging a revaluation, or create a backlash. One indication of the direction will be whether China will block the IMF from publishing a detailed summary of the board’s Monday deliberation over the next few weeks. The full IMF analysis would likely be published in September unless China withholds its permission.

IMF members are entitled to block publication of IMF reviews, though most now allow publication. The U.S. has been pressing Beijing to permit publication.

China hadn’t allowed the IMF to conduct an annual review of its economy since 2007 as the two sides fought over China’s policy of pegging the yuan tightly to the dollar, a policy that China put in place in 2008. The U.S. and Europe—the IMF’s largest shareholders—complained that policy gave Chinese exporters an unfair advantage. The IMF began the current review in the spring of 2010.

Eswar Prasad, a Cornell University economist and a former head of the IMF’s China desk, said a draft of the IMF staff report he had seen noted positively Beijing’s decision to let its currency float. The report also highlighted that China’s current account surplus had fallen in recent months—which could be an indication that the currency is properly valued. But the IMF forecast that the change in the surplus was only temporary, a determination it had made in April as well.

“Significant action” was needed to reduce the undervaluation, Mr. Prasad said.

Brazil largely backed the Chinese position that the reduction in China’s current account balance could be long lasting, said the country’s IMF representative, Paulo Nogueira Batista.

Chinese officials argued that “they have done what they needed to do and the rest of the world should give them room” to act, he said. Another individual familiar with the deliberations said the report’s finding hadn’t changed significantly from the draft.

In Ms. Hu’s latest statement on the yuan, which was posted on the central bank’s website, she focused on the dangers of inflation. That is familiar territory for any central banker, but Ms. Hu turned up the rhetorical heat by quoting legendary free-market economist Milton Friedman’s statement that inflation is “a dangerous and sometimes fatal disease.”

“Looking at China’s situation, those who suffer greatest from inflation are the low-income masses, especially China’s over 40 million poor urban residents and nearly 100 million poor migrant workers, a situation which if improperly handled will affect social equality and stability,” she said.

Such comments probably indicate that the central bank would like to allow the yuan to appreciate further if it perceives inflationary risks, economists said. But major decisions on currency and monetary policy require approval from China’s top political leadership.

At the moment, most economists generally see China’s current inflation rate as manageable and don’t see a need for a major policy shift to stop price increases. China’s consumer price index rose 2.9% from a year earlier in June, down from May’s 3.1% rise.

Ms. Hu said that although the consumer price index has “basically stabilized at a low level” in recent years, other measures of price levels, such as the producer price index, real estate prices and other asset prices, have all risen by larger margins.

She said that China faces inflationary pressures from the capital flowing into the country from its massive trade surpluses with the outside world. To keep the currency from rising sharply, the central bank has been forced to buy up the incoming foreign currency with yuan, thus increasing domestic money supply, she said.

Beijing Considers Plan To Move Its Currency Further From Dollar

Beijing Considers Plan To Move Its Currency Further From Dollar, Wall Street Journal
July 23, 2010

BEIJING—China will consider publishing an effective exchange rate for the yuan against a range of other currencies in an effort to de-emphasize its value against the dollar, in a further indication of how Beijing plans to manage the yuan since effectively decoupling it from the U.S. currency.

People’s Bank of China Vice Gov. Hu Xiaolian said in comments published on the central bank’s website Thursday that China will consider gradually moving toward using the effective exchange rate as a reference point for the yuan. The effective exchange rate is an estimation of the value of a currency relative to a group of other currencies, weighted based on the amount of trade between the countries.

If China were to adjust the value of the yuan based on its effective exchange rate, it could mean less focus on the bilateral yuan-dollar rate. However, the comments didn’t name currencies or offer additional details about how such a basket would work.

The statement marks the second time Ms. Hu has commented on the yuan’s exchange rate since China effectively ended the yuan’s peg to the dollar on June 19. The PBOC hinted then that it was moving to a new currency regime that would focus more on guiding the yuan against a basket of currencies.

The peg helped keep the yuan’s value stable in comparison to the dollar, reducing currency volatility as Beijing looked to foster the country’s torrid growth rate. But U.S. lawmakers, leaders from competing countries and others argued that the peg gave China an unfair advantage by keeping prices of its exports low.

Economists cautioned against reading too much into the statement, saying ambiguities remain in China’s stance, even if it is becoming clearer that a basket-based system is the long term goal for exchange rate policy. China’s central bank isn’t independent, and decisions on monetary policy and the exchange rate require the approval of the country’s top political leadership.

“The PBOC has always had these kinds of views, but they don’t have the power to make these kinds of decisions,” said Goldman Sachs economist Yu Song.

Also Thursday, Chinese Premier Wen Jiabao said policy stability will be the basis of the government’s economic work in the second half and that Beijing aims to maintain steady and fast economic growth in the long run. Mr. Wen’s comments suggest the government is placing slightly more emphasis on maintaining fast economic growth than it did in the first half, after China’s gross domestic product growth slowed to 10.3% in the second quarter from 11.9% in the previous quarter as stimulus spending continued to wind down gradually and controls on bank lending and property speculation began to be felt in the broader economy.

A strict linking of the yuan to a basket of currencies is unlikely in the near term, analysts say, as it would mean the yuan could fall against the dollar when the U.S. greenback is rising against other currencies, which could enrage parties in the U.S. calling for yuan appreciation.

Standard Chartered economist Stephen Green said the statement appeared to be part of an “education campaign” on the importance of the effective exchange rate. “But they haven’t said what’s in the basket, and they aren’t claiming to be linking to a basket, they are just telling us that they are referencing one,” he said.

China said it would reference a basket of currencies when it first unshackled the yuan from the dollar in July 2005. But it went on to allow a steady appreciation against the dollar for around three years, with no apparent reference to a basket. China resumed pegging the yuan to the dollar in 2008, in the midst of the global financial crisis.

In her statement Thursday, Ms. Hu said China’s intention has been to reference a basket since its initial exchange rate reform in 2005, “but the idea of only focusing on the yuan-dollar exchange rate is hard to change in the near term,” due to long-established habits, accounting practices, and other issues.

Ms. Hu said China may attempt to periodically announce estimates of the yuan’s nominal effective exchange rate, “to guide the public to change the habit of mainly focusing on the bilateral exchange rate with the dollar.”

The Bank of International Settlements publishes monthly estimates of the effective exchange rates of various countries. A key factor in determining the rates is deciding what weighting to give individual currencies, which BIS sets according to levels of trade in manufactured goods.

Ms. Hu said China’s weighting calculation will be mainly based on current account payments, but also take into account capital account payments and the currency composition of cross-border capital flows, among other factors.

Ms. Hu also said other factors will be considered in determining the yuan’s exchange rate, including jobs and the potential for large-scale company closures. The exchange rate will be based on economic conditions and the international balance of payments to avoid fluctuations in international and domestic markets, and speculation in financial markets, she said.

Any adjustment of the exchange rate should take into account the global economic situation, Ms. Hu said. Big trade surpluses posted after the exchange rate is adjusted would show that companies can tolerate the exchange rate change, but if there is a rapid decline, it would mean companies need to increase their capability of adapting to changes in the yuan’s exchange rate, she said.

—Aaron Back, Liu Li and Victoria Ruan

“Early View on China’s Currency Overhaul: Little Change,” Wall Street Journal

Early View on China’s Currency Overhaul: Little Change, Wall Street Journal
July 16, 2010
Aaron Back, Andrew Batson, and Bob Davis

A month after China announced it would ease its currency’s de facto peg to the dollar, the yuan has gained just 0.7% against the dollar, and the stated policy shift has done little to defuse political anger at China in the U.S.

Four weeks isn’t enough time to judge the full impact of China’s intent, but, so far, this doesn’t have the hallmarks of a major shift to a more-flexible currency. More than half the appreciation of the yuan thus far came on the first trading day after the announcement. In the past two weeks, movement has largely halted.

But Americans aren’t waiting. The currency move thus far is “woeful,” said AFL-CIO President Richard Trumka, who says the yuan is undervalued by 40%. “Even if it increased 0.7% a month for a year, it would be woeful,” he said.

Frank Vargo, a National Association of Manufacturers’ vice president, said, that without a greater appreciation, “there will be a fair amount of pressure to do something” on Capitol Hill to penalize China.

But any substantive move against China in Congress is unlikely until after the November elections because lawmakers are focusing on other priorities, including deficits, taxes and unemployment, said Mr. Trumka.

Sen. Charles Schumer, a New York Democrat, whose legislation would make it easier to take punitive action against Beijing, said in a statement, “There hasn’t been an opportunity yet in the last month to bring our proposal to the Senate floor…We continue to push our legislation and are looking for the first available opportunity to offer it.”

On Thursday, a deputy governor of the People’s Bank of China reaffirmed the central bank’s commitment to currency flexibility and pointed out its benefits. The comments by Hu Xiaolian are the first lengthy elaboration of PBOC views on currency policy since the June 19 announcement. The remarks, published on the PBOC web site in both English and Chinese, are noteworthy because they echo much of the criticism of China’s tightly controlled exchange-rate regime leveled by the U.S. government and International Monetary Fund.

Ms. Hu said a fixed exchange rate would be dangerous to the nation’s economy and that rigid exchange rates had contributed to financial crises in the past, including in Mexico in 1994, Argentina in 2001 and several Asian countries in 1997. “Thus, it is necessary for large countries to have (a) flexible exchange-rate policy,” she said.

The People’s Bank of China has been the leading voice for currency reform within the Chinese government, arguing against the Commerce Ministry and others who said letting the exchange rate rise would hurt Chinese exporters by making their goods more expensive in dollar terms. The central bank’s argument won out with China’s top leaders, who treasure stability but want to strengthen domestic consumption and reduce China’s reliance on exports.

Conditions that preceded both unpeggings in 2005 and 2010 are similar: in China, the economy is surging, and in the U.S., political impatience with Beijing’s currency policy is gaining steam.

When China unpegged the yuan from the dollar in July 2005, the currency gained about 2% during the first month of trading—and nearly all on the first day. In the first year, the yuan rose just 3.5%, and over a three-year period, gained a total of about 21%. Beijing re-established the peg in mid-2008 as the global recession took hold. This time around, at the current rate of appreciation, the yuan would rise more than 8% over a year—though there is no guarantee the Chinese plan a steady increase.

The recent change in policy was announced shortly before leaders of the Group of 20 leading and developing nations met in Toronto, taking China’s exchange rate off the agenda and making it easier for the U.S. Treasury last week to, again, avoid declaring China a currency manipulator in a congressionally mandated report.

Shortly after Beijing announced its move, President Barack Obama suggested that the U.S. would judge China’s progress “over the course of a year,” but later, telling reporters about a conversation he had had with Chinese President Hu Jintao, Mr. Obama truncated the time frame to “the months ahead.”

The small appreciation thus far has the Obama administration and Congress looking for levers to keep the pressure on China. Treasury Secretary Timothy Geithner has said “what matters is how far and how fast the renminbi appreciates.”

The next lever may be IMF review of China’s economy, likely to be completed in September. China had blocked the IMF from undertaking a review —generally done annually—since 2007 as the two sides squabbled over China’s currency policy. IMF officials regularly describe China’s currency as “substantially undervalued.” The U.S. is pressing China to permit the publication of the IMF review., which could focus international attention again on China’s currency policy.

A widening of the U.S. trade deficit with China amid widespread concern about unemployment is likely to prompt congressional rhetoric—if not action—to act against China. In May, the U.S. trade deficit with China expanded to $22.3 billion, the widest since October. “I think the knives will come out fairly soon,” predicted Cornell University economist Eswar Prasad, a China specialist.

China took pains to signal that movement of the currency would be gradual, and that the yuan could fall as well as rise. Such a strategy is aimed at fending off speculative flows of capital betting on currency appreciation, one of the chief drawbacks of a controlled exchange-rate regime. The fact that the yuan isn’t predictably and consistently rising against the dollar thus achieves one of China’s main economic goals, even though it worsens political strains with critics abroad.

Chinese officials point out that the yuan has appreciated substantially against the sagging euro this year, even though it has moved little against dollar.
—Liu Li contributed to this article.

http://online.wsj.com/article/SB10001424052748703722804575368970567812464.html

James Bacchus, “A Trade War With Zero Currency”

A Trade War With Zero Currency, Wall Street Journal
July 12, 2010
James Bacchus

In the past, U.S. congressional threats to slap tariffs on Chinese imports in retaliation for the perceived trade effects of Chinese currency practices were only threats. Now, for the first time, there is a real chance these threats could lead to action.

That’s because the debate in America is changing. Mainstream politicians, the media and even businesspeople are starting to call for action against Beijing. Earlier this month, Andy Grove, former chairman and chief executive of Intel, said the U.S. should “levy an extra tax on the product of offshored labor. If the result is a trade war, treat it like other trade wars—fight to win.” He is far from alone in urging such action.

Thus, there’s growing support in Washington for punitive legislation sponsored by Senator Charles Schumer. The New York Democrat wants to change U.S. law to permit additional tariffs to be applied to Chinese imports to offset the “subsidy” provided by the yuan’s alleged undervaluation. The level of those tariffs could exceed many billions of dollars annually.

Evidently, Senator Schumer has been persuaded that this action would somehow be consistent with U.S. obligations to China under the international rules on which both countries have agreed as members of the World Trade Organization. It is not at all clear that it would be.

Chinese currency practices benefit Chinese producers generally. To fit the definition of a “subsidy” under WTO rules, a governmental action must take the form of a “financial contribution” that, unless conditioned on exports or on the use of domestic over imported goods, must also be “specific” to “certain enterprises.” Successfully defending the notion that Chinese currency practices meet this definition would be difficult, to say the least, in WTO dispute settlement, where there is no precedent for such an assertion or such a ruling.

But given that America is in the middle of a “jobless” recovery, where five unemployed Americans are still seeking work for every one job available, such a move could prove popular. Few members of Congress seeking re-election in November are likely to be dissuaded from voting for such legislation because it may be inconsistent with international law. They would only see the immediate political benefit.

Nor are they likely to be deterred by the possibility of losing a WTO case to China a year or two from now. By that point, they would already be re-elected. Never mind the extensive and expensive trade sanctions that could later be applied lawfully by China if the U.S. lost at the WTO and refused to comply with the verdict.

To his credit, President Barack Obama has refrained from indulging in inflammatory rhetoric or taking precipitous action on the currency issue. Last week, Treasury Secretary Timothy Geithner declined to name China a currency manipulator under U.S. law. Clearly, the Obama administration continues to prefer quiet diplomacy to confrontation as the best course for resolving the currency dispute.

The Chinese government no doubt wants to defuse the situation, too. On the eve of last month’s Group of 20 meeting, Beijing announced it would drop the yuan’s peg to the dollar and let the value of its currency rise. This cooled the heat on China at the summit in Toronto, but it unfortunately didn’t lower the rising political temperature in Washington.

That’s partly because China simultaneously assured its own exporters that the value of the yuan will rise only gradually. Since the announcement, the yuan-dollar exchange rate has hardly budged. Mr. Geithner recently noted he would track “how far and how fast” the value of the yuan rises.

Despite his best intentions, Mr. Obama may not have the votes in Congress to stop the Schumer bill. Many Americans believe the yuan’s weakness makes Chinese exports to the U.S. cheaper and U.S. exports to China more expensive, robbing America of millions of jobs and contributing to America’s large trade deficit with China. It would be hard for the president to veto such a popular piece of legislation in the midst of an election campaign when his party’s continuing control of Congress is in dire jeopardy.

Both sides must act to calm these tensions before the world’s most important trade partners become embroiled in a mutually self-defeating trade conflict. The Schumer bill, if enacted, would thwart ongoing efforts in both countries to sustain the fragile global economic recovery and create more jobs and more prosperity in America and China alike. Whatever the pressures politically, America’s best interest economically is in keeping America open to growing and mutually beneficial two-way trade with China.

For its part, China can stop relying on cheap exports for growth, and start relying on spending by Chinese consumers in its rapidly developing economy. China could also reconsider “indigenous innovation” and other short-sighted, protectionist policies that make U.S. and other trade partners and investors fear that China is retreating from liberalization. Above all, the farther and faster the yuan rises against the dollar, the sooner and more significant the easing of trade tensions.

These actions would do much to help President Obama and others in the U.S. who are trying hard to stop the tariff-rattling and bring the two countries back from the brink of a destructive trade war. It’s in everyone’s interests that they succeed.

Mr. Bacchus is a former chairman of the World Trade Organization’s Appellate Body, congressman and U.S. trade negotiator. He is currently a partner at Greenberg Traurig in Washington.

Alan Beattie and James Politi, “US welcomes loosening of renminbi peg”

US welcomes loosening of renminbi peg, Financial Times

By Alan Beattie and James Politi in Washington

Published: July 9 2010 02:39 | Last updated: July 9 2010 02:39

The US declined to name China as a currency manipulator in a politically sensitive report on Thursday, citing Beijing’s loosening of the renminbi peg in June as “a significant development”.

The report had been delayed from April as part of a process of quiet diplomacy to encourage China to allow some flexibility in the exchange rate.

The renminbi, which was allowed to float upwards by 21 per cent between July 2005 and July 2008, was then repegged in response to the financial crisis. Beijing said on June 19 it would permit some movement but did not commit itself to a target.

Tim Geithner, Treasury secretary, said: “What matters is how far and how fast the renminbi appreciates.”

Mr Geithner, who has been criticised by some lawmakers for failing to push Beijing hard enough, said: “We will closely and regularly monitor the appreciation of the renminbi … in close consultation with Congress.”

Key lawmakers said that China would have to allow faster appreciation of the renminbi then previously. Sander Levin, chairman of the House ways and means committee, said: “This is a first step, but clearly only that.”

Members of Congress have threatened legislation to restrict Chinese imports on the grounds that the currency is undervalued and preventing US companies from competing.

“We must monitor China’s progress but also give serious consideration to all options in the event, as was the case in 2005-08, that China fails to take the additional necessary steps,” Mr Levin said.

Naming a government a manipulator, which involves a complex set of criteria, carries no sanctions except a commitment to start negotiations, which in the case of the US and China have been under way for years.

Meanwhile, the International Monetary Fund said on Thursday the US economy had rebounded faster than expected but faced the threat of contagion from sovereign debt problems in Europe.

In an advance summary of its annual health check of the US economy, the IMF said: “While still modest by historical standards, the recovery has proved stronger than we had earlier expected, owing much to the authorities’ strong and effective macro-economic response.”

The release of the report was accompanied by good news on the economy, which contrasts with a run of recent disappointing data. The number of Americans filing for jobless claims last week fell more than expected, offering some measure of comfort that the recovery in the labour market is advancing, albeit slowly.

But the IMF warned that, along with risks of renewed weakness in the US housing market, international events of recent months had introduced risks to the recovery.