Even given the laughably bad U.S. government record in gauging China’s trade and economic intentions and defending American economic interests against Chinese predation, Washington’s recent pronouncements and decisions on China’s currency policies have been abysmal. And they look worse and worse by the day.
Specifically, the Chinese seem to have taken the United States – and the rest of the world – to the cleaners. On the one hand, Beijing has apparently convinced American and global authorities that it’s becoming a responsible global financial player. On the other hand, it’s unmistakably resumed weakening its currency for trade advantage.
In recent years, the case for optimism about China’s role in the world economy has rested on what has been described as Beijing’s growing commitment to economic and financial reform. As the optimists noted, China had loosened its control over its currency even though this freer float had resulted in a strengthening of the yuan versus the U.S. dollar. All else equal, this approach eroded the price advantage enjoyed by Chinese goods versus their foreign counterparts due to China’s longstanding efforts to keep the yuan artificially cheap.
This increasingly hands-off currency policy, in turn, appeared to signal a broader resolve by China’s leaders to turn its entire financial sector into a genuine banking system rather than a mechanism for the state to dominate resource allocation. At the end of that road arguably lay a fundamentally more market-based, and thus healthier, Chinese economy – and possibly even a more democratic China, since the government would no longer be calling so many crucial economic shots.
In return, China has received nearer-term two major rewards. First, the International Monetary Fund (reflecting the views of the United States and other major economic powers that set its policies) admitted the yuan into it’s so-called basket of international reserve currencies. The main impact was symbolic, reinforcing the reality of China as a leading force in the global economy. But this is the kind of status that’s highly prized not only by Chinese leaders but by the entire society they rule – not to mention by many of their Asian neighbors.
Second, the yuan’s rise eased some of the pressure China faced to trade more freely. Here, the effect was mainly multilateral. The U.S. government has never responded effectively to Beijing’s currency manipulation, but the stronger yuan clearly helped Congress decide to fast track President Obama’s Trans-Pacific Partnership (TPP) agreement when it began considering passage despite its lack of enforceable currency rules. Although China is not yet a member, it stands to benefit handsomely, if only because of the deal’s loopholes, and its new currency stance enabled the president to portray a successful, informal jaw-boning campaign against the world’s leading instance of exchange-rate protectionism as a better approach than formal rules and sanctions.
Yet it’s become ever clearer that the yuan’s most recent months of strengthening reflected not a Chinese conversion to so-called fair trade, but the Chinese government’s need to stem the capital flight brought on by its broader prestige-focused financial reform measures. In effect, Beijing was facing the inevitable price of liberalization – especially in the face of an economic slowdown and a burst of turmoil in its so-called stock markets.
The United States and the world’s other leading powers might have been able to hold China’s feet to the fire by postponing the yuan reserve currency decision until Beijing demonstrated that its reforming ways would persist despite short-term economic pain. (A tougher TPP would have helped, too.) But they squandered their leverage by rewarding China prematurely – and the Chinese have taken full advantage. Since the yuan was officially brought into the reserve currency basket on November 30, its value versus the dollar has slid by nearly 0.80 percent. In the world of exchange rates, that’s a big change, especially in less than two weeks.
Further, this yuan weakening has come on top of the gargantuan near-two percent devaluation announced by China in mid-August. All told, since then, the yuan has fallen versus the dollar by a stunning 3.85 percent. Moreover, it’s been reliably reported that China has just tightened its capital controls again, and in recent weeks has ramped up its efforts to close the black market channels through which wealthy Chinese have been illegally transferring massive amounts of wealth abroad. The obvious implication is that, however much they value global prestige and the long-term economic benefits of reform, China’s leaders remain first and foremost determined to keep propping up the economic growth on which their political power ultimately depends.
As a result, unless the IMF kicks the yuan out of the reserve currency basket, and/or the United States either adds meaningful currency manipulation curbs to the TPP or, even better, acts unilaterally (don’t hold your breath), China and its leaders will be able to reap all the benefits of greater protectionism while continuing to pay none of the costs. For years, the world’s economic powers-that-be have been declaring China to be an increasingly “responsible stakeholder” in the global economy. But it actually looks more and more like they have a much bigger stake in perpetuating this delusion.
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