Cool heads required on yuan valuation
The vexed dispute over the yuan has spawned a cottage industry. It offers US politicians - Democrat and Republican - a rallying cry. Pundits, on the mainland and in the US, pontificate in endless columns, while economists build complicated models to determine the currency's proper value. At the very least, the debate has helped create employment for many people in these economically difficult times.
As substantial as it is, the yuan dispute is nothing new. More often than not, it serves as a signal of where relations are moving at any given time between China and the US. US Treasury chief Timothy Geithner's surprise visit to Beijing this week is a positive sign that the so-called Group of Two now prefers a diplomatic dance over a shouting match. It comes at a time when Beijing is willing to accommodate a US-led campaign to impose tougher sanctions against Iran, while President Hu Jintao is expected to attend the nuclear security summit in Washington next week.
Before his visit, Geithner postponed the publication of a twice-yearly currency report which might accuse China of being a currency manipulator. In turn, Chinese finance officials have apparently been laying the groundwork for the yuan to resume its appreciation, most likely at a snail's pace. In other words, the US agreed to delay what it would probably not have done in the first place, while China seems poised to do what it has been planning to do with the yuan anyway! To be sure, many economists have warned the undervaluation of the yuan is perpetuating the trade imbalance by giving Chinese exporters an unfair advantage - thereby hindering global economic recovery. Others have argued the currency may already be at a fair value. Rather more improbably, a few even think it is slightly overvalued.
Since there can be no definitive answer as to what the yuan's proper value should be, the matter can only be resolved politically. That is when cool heads in China and the US decide that co-ordination is better than confrontation. The two economies are so intimately tied that the risk of a trade war is too scary for both sides to contemplate seriously. Since Geithner's visit, markets are predicting a modest appreciation for the yuan. Twelve-month forward contracts are pricing in a 3 per cent or less rise against the greenback. There is a strong sense of deja vu in all this. In 2005, after another cycle of disputes with the US, Beijing let the yuan appreciate over the next few years by 21 per cent. On a trade-weighed basis, it may have even gone up by 27 per cent. This was only halted in the summer of 2008 with the onset of the economic meltdown. As exports collapsed, Beijing allowed the yuan to stay at about 6.83 to the US dollar and to fluctuate within a narrow band.
Now, as Beijing withdraws liquidity from the economy, it realises the economy needs to structurally adjust. Domestic demand has been boosted to make up for losses in exports. Growing asset bubbles and rising inflation need to be addressed. All these factors point towards the need for the yuan to appreciate. But Beijing also needs to take care of exporters, many of whom survive on razor-thin margins. Any sudden and drastic rise in the value of the yuan would be economic suicide for an economy that remains heavily dependent on exports.
Beijing's insistence that any yuan appreciation must be gradual is therefore not only a matter of policy, but necessity. Even so, depending on its pace, it should be an acceptable compromise with China's trading partners, including the US.
