US calls for immediate flexibility on renminbi
The US administration is calling for China to move immediately to introduce a flexible currency, a marked shift in tactics after several years of patient diplomacy aimed at nudging China towards allowing the renminbi to float.
Officials acknowledge they were shocked by a 67-33 Senate vote this month to allow consideration of a bill championed by Democratic senator Charles Schumer that would impose a 27.5 per cent tariff on all Chinese imports if China does not revalue in six months.
There is also concern within the administration about possible House efforts to give the Commerce Department more say in the decision on whether China is manipulating its currency. The Treasury dismisses that threat to its authority.
One thing you always hear is that the Chinese banking system isn't ready for a floating currency. The following, from Asia Times Online, makes the connection between revaluation and the internal Chinese debt situation. Not particularly well-written, but at least it gets the facts across:
It's not the yuan, silly
By Francesco Sisci
BEIJING - First, they said it must be devalued. Now they want it to be "revalued".
It was the eve of the 1997 Asian financial crisis when the world first raised the chorus for yuan's devaluation. The logic of the markets then: the economy is in a shambles and the banks have run up unmanageable debts; if the yuan is not devalued, Chinese exports would soon become too expensive to hold their position and foreign capital would stop flowing into the country.
The Chinese government then thought there was little to gain from devaluation. It would trigger another round of competitive devaluation from other Asian currencies, which would eat into the newfound advantage of the yuan. So Beijing decided to hold on to its fixed peg to the dollar and boost exports by cutting taxes on exporting companies so that commodity prices went down in dollar terms. The strategy won. Asian currencies stabilized, the dollar went slowly down vis-a-vis other Asian currencies and the new kid on the block, the euro.
The lesson that China learned was that with currencies, one should not lose one's head, even if everyone else in the market is losing theirs. This is a lesson worth keeping in mind amid today's chorus for revaluation. Pundits point at China's long-lasting trade surplus, the gains in its labor productivity, the bulging foreign reserves, the low inflation rate and the country's contribution to global growth to draw the conclusion that yuan is going too cheap. Among their many arguments: a can of Coke or a Big Mac in China costs half of that in the United States, hence the yuan must go up 20-40%.
One more bandied about suggestion is to broaden the exchange band and let the yuan shoot up by some 10%. But if that were to occur, it could well trigger bigger problems. Hot money would have one more reason to come in...Given the country's steady growth, any revaluation of the yuan would only open the floodgates to hot money.
Moreover, China might not be ready for a huge flow of investment into or out of the country. Its stock exchange is, basically, a waste bin. It's the legacy of a time when the state used the share market to rip off small investors to finance non-performing state-owned enterprises (SOEs). But there was a moral angle to this rip-off: the SOEs were supporting workers and the social fabric of urban China. The state and the market needed reform and reform needed money, but there was none available. At the same time, there were lots of people making money, often walking in a gray line between legal and illegal in the shifting paradigm of China's economy in the 1990s....
So the stock exchange worked for both the investors and the state: it gave the state the cash for reform and investors an avenue to distil their ill-gotten money. Even if they were to be ripped off, they couldn't complain too much - the money was easy come, easy go.
Almost everybody in China has done something not perfectly legal with his or her money. In the past, even subletting one's apartment could make one liable for persecution. Thus no one wants to volunteer information on their wealth to the banks and risk a police inquiry into past history. So banks are mainly left with SOEs as their main clients, no surprise then that half the Chinese money is cash circulating outside the banking system.
But money must go back to banks as cash transactions are clumsy and open to deception.. However, for banks to be trusted and not seen as conniving with tax and police officials, there needs to be some kind of an amnesty for past economic "crimes" - something that would pardon, say, tax evasion, but help isolate cases of drug trafficking. Free flow of foreign money in China before all this is done could destabilize the Chinese economy.
Finally, there's the opinion of the IMF, the world's Federal Reserve, that now is a good time to revalue:
Good moment for flexible renminbi says IMF
By Geoff Dyer in Shanghai
The head of the International Monetary Fund said on Tuesday that now was a “good moment” for China to begin moving towards a more flexible exchange rate because of the strength of its economy.
Rodrigo Rato, the IMF's managing director, said the decision on timing was a question for the Chinese government but argued a flexible exchange rate and more open capital account would help China better cope with external shocks.
“These types of changes from inflexible to flexible rates should be done in times of economic strength,” Mr Rato said during a visit to Shanghai. “For China, this is now a good moment.”
His comments come a day after Chinese premier Wen Jiabao said the government would eventually move away from its fixed dollar currency peg, but warned that some countries underestimated the impact a renminbi revaluation would have on Chinese companies and the global economy.
Me, I'm of the opinion that it should float, of course, but implementation will be key to preventing a crisis during the transition. It should be obvious, one hopes, that the US Congress is armed and ready to do something seriously stupid, which should be enough to get all sides off their duff and acting on a practical plan for said implementation. The situation is coming to a head, and the consequences could be ugly.
(Crossposted to my journal)