The Currency War: Post-Seoul

Those of us involved with China on a daily basis have been living with currency issues for a long time. Ever since China began racking up large trade surpluses with the United States, politicians and special interest groups in the United States have been charging that China keeps the renminbi undervalued in order to make products produced in the country more competitive in global markets.

Over the past several weeks, though, as the term “currency war” has become such a big part of the business vocabulary, I have met with many businessmen who are literally scratching their heads, wondering what it all means. In past articles, I have tried to explain China’s views on its currency, but I have stopped short of providing a prediction as to how this will all play out in the coming months. With the meeting of the G-20 finance ministers in Seoul behind us, I believe that we can now draw some conclusions. So, here goes.

While the rhetoric coming out of the meetings in Seoul sounds positive, nothing concrete was agreed. This was not unexpected. The lead sentence in the Wall Street Journal article about the meeting summed it up pretty well. “The Group of 20 nations are pursuing an accord to end battles over currencies that relies on goodwill and peer pressure rather than enforceable sanctions.” With so much at stake in the two largest countries of the world—the United States and China—I don’t see how goodwill and peer pressure works.

What were the results of the meeting?

First, the United States, China and Japan agreed to “be vigilant against excess volatility and disorderly movement in exchange rates” and China agreed to “move towards more market-determined exchange-rate systems that reflect underlying fundamentals.” Huh?

Second, finance ministers agreed to try to maintain trade balances—which are both a reflection of and a determinant of exchange rates—at “sustainable levels.” Unable to agree on a precise metric, as the U.S. proposed, the ministers agreed only to measure compliance by “indicative guidelines,” still to be negotiated.
Unfortunately, the G-20 lacks any enforcement mechanism.

Third, the International Monetary Fund was chosen to be the umpire. Ditto in terms of enforcement.

Finally, a goal was set to finalize a currency deal, including a range of criteria for judging a nation’s economic policies, in time for the Seoul summit of G-20 leaders on November 11 and 12. We’ll see.

With that as background, here is what I believe will happen:

1. China will continue on its policy of a gradual appreciation of the renminbi against the dollar. Assume a five to seven percent annual increase in the value of the yuan for the foreseeable future.

2. China will not agree to a one-time, large increase in the value of the renminbi as Japan and Germany did in 1985, nor will it agree to limits on the percentage of its trade surplus as a percentage of GDP as Treasury Secretary Timothy Geithner proposed in Seoul.

3. In order to try and stimulate the economy, the United States Federal Reserve System will make good on its plans to employ a policy of monetizing the growing U.S. debt by making significant open market purchases of government bonds. While government officials profess their belief in a strong dollar, the effect of this so-called “quantitative easing” is to weaken the currency. Any economist will tell you that a weaker currency is the inevitable result when governments begin to print money.

4. If the Obama Administration or the United States Congress were to slap tariffs on goods made in China, or try and apply other penalties to China trade, China will respond with trade measures that are roughly equal. In other words, China will respond in a measured way, but will not escalate the dispute.

5. One bi-product of any trade dispute with the United States will be that U.S. companies may face a slowdown in obtaining necessary approvals in China. While this will not be a stated policy on China’s part, the pace of bureaucracy will definitely slow.

6. As in all disputes between the United States and China, cooler heads will ultimately prevail in any open dispute between the two countries on trade or currency. The United States and China simply have too much to lose in a prolonged confrontation of any sort.

After all is said and done, we may be heading into choppy waters, but in the end, both the United States and China will pursue economic policies that they believe are in their own best interests, but will stop short of launching a full-blown currency war.

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