To US critics of China’s currency: get your own house in order

The noise coming from the US about China’s supposed “manipulation” of its currency, the yuan (also referred to as the renminbi), has become noticeably louder this past week.

Since July 2008, China has pegged its currency at about 6.83 yuan to one dollar. American critics assert that China’s policy effectively keeps its currency artificially low, with the aim of boosting its exports. The charge is that this gives China an unfair advantage in world trade.

Disparagement of China’s policy from Washington has been building up recently. President Obama promised last month to “get much tougher” on China’s currency approach. And on Monday 130 congressmen demanded that the treasury secretary Timothy Geithner label China a currency “manipulator” in its forthcoming foreign exchange report to congress.

Kicking off this week’s debate, Paul Krugman argued in his New York Times column on Monday that China’s policy of keeping its currency undervalued “has become a significant drag on global economic recovery. Something must be done.” That something is to confront China with “policy hardball”, and impose a temporary 25 percent surcharge on Chinese imports. Two days later, the Times’ lead editorial echoed Krugman’s criticisms: “China’s decision to base its economic growth on exporting deliberately undervalued goods is threatening economies around the world.”

The relative strengths of currencies normally reflect the relative strengths of underlying economies, over time. Many economic studies find that China’s currency is undervalued, but estimates of the extent of undervaluation range widely. As Daniel Ikenson of the Cato Institute notes, no one really knows for sure, primarily because China does not allow its currency to float freely and it maintains strict controls on capital.

But while China might have tighter controls than other countries, as the lead editorial ("The yuan scapegoat") in today’s Wall Street Journal points out, all countries “manipulate” their currencies by means of setting interest rates and other policy interventions. The US periodically announces its intention to attempt to position the dollar at a certain level vis-à-vis other currencies. As Stephen Roach, economist and chairman for Morgan Stanley Asia, correctly noted:

Isn’t it the height of hypocrisy an American can articulate a particular position in its currency but the Chinese are not allowed to do that. Especially since they as a developing economy with an embryonic financial system need a currency anchor probably a lot more than more ‘sophisticated economies’ like the United States.  

A key problem with the American focus on China’s currency is that it ignores the US’s underlying economic weakness, which is the real reason behind its trade deficit. Specifically, there is an assumption held that, if China were to let the yuan increase in value, the US would benefit significantly. The American trade deficit will vanish, millions of jobs will be created, and an economic boom will take off. It ain’t gonna happen.

Say the yuan did increase in value. This would make Chinese imports into the US dearer, but US companies would not benefit, as they have generally stopped making the type of goods that China sells in the US. The beneficiaries might be other developing countries, but it isn’t certain they can provide substitute goods that Americans will buy; in the short-term, Americans would pay more as they continued to buy Chinese goods. Similarly, a cheaper dollar would not necessarily transform US exports to China, as US goods would face competition from other major countries, such as those in Europe. Moreover, rising exports, on their own, are unlikely to drive an economic upturn, given how much of the US economy is still domestic-oriented.

The argument from the US is self-serving, and aims to boost the US at the expense of China. But American critics have a fallback argument: China’s policy is bad for the whole world economy, especially developing countries. That was the New York Times’ editorial line yesterday, but even the Times had to admit that the “drumbeats of complaint” were coming from Washington and there was a “deafening silence pretty much everywhere else.” Not for long. Shortly after, both the World Bank and the International Monetary Fund called on China to allow the yuan to rise. Writing in the Financial Times, Arvind Subramanian, a senior fellow at the Peterson Institute for International Economics, recommended the World Trade Organization be utilized for developing new multilateral rules that would encourage China to drop the dollar peg.

If anything, these attempts to cloak American interests in multilateral negotiations are worse than populist tub-thumping. On the specific issue of currency, neither the US nor China is “right” from an objective point of view; both are pursuing what they believe to be their national interests. But as economics journalist Daniel Ben-Ami rightly argues: “Each country is entitled to pursue what it sees as its particular interests, but to pretend their respective viewpoints represent the greater good is not credible.”

American criticisms of China are myopic. Last year, while the US economy declined 2.4 percent, the Chinese economy grew by 8.7 percent. China’s growth is expected to well out-pace America’s in 2010. That advantage cannot be explained by China’s currency policy. Moreover, the global economy faces many problems in restoring growth, and China's approach to the yuan far from being top of the list.

Instead of lashing out at China in un-diplomatic terms, and risking a trade war, the US should seek to get its own economic house in order. There is so much to be done that the US cannot afford to waste time and energy in distracting attacks on China. If the US can restore a dynamic, productive economy, its trade balance will take care of itself.