Will China Revalue Its Currency?

This morning’s Financial Times carries an interesting piece by Andrew Balls and Richard McCregor on China’s “dollar dilemma”.   Should she revalue the renminbi (currently pegged at Rmb8.28 to the US dollar) for the first time in more than a decade?


Rumors of an impending turn in China’s exchange rate policy have been rife since the Asian economic meltdown during the late 1990s.   Back then, the US current deficit, according to Balls and McCregor, “could be seen as a reflection of private capital flows, attracted by the [US’s] strong productivity growth”.   This time, however, things are different.


Now, the deficit (estimated at nearly $700bn, or nearly 6 per cent of GDP) can largely be laid at the door of foreign state banks (mainly from Asia) buying US treasury bonds.   China alone holds more than 40% of all foreign exchange reserves held by developing countries.   In many ways, it is countries like China, by continually buying the US dollar in its weakened state (down nearly 20% since the Asian crisis of 1998), that have financed Bush’s war in Iraq and the substantial tax cuts of the past two years.


At the same time, the current trade imbalance with China ballooned this week to $328bn — the largest ever — and there are rumblings in Congress that the current exchange rate regime is added support for China’s ruinous exports.   This reflects the concern of the G7 that currency “flexibility” on the part of Asia is a necessary first step in “rebalancing” the world economy.


All this is part of a larger program program of reigning in the Chinese economic powerhouse.   The Bush administration has enlisted Japan, especially, in this undertaking.  The Wall Street Journal this morning reports that Tokyo has begun allocating to Japanese companies the rights to drill for natural gas in waters claimed by China.   This comes at a time of increased tension between the two Asian countries, due largely to Japan’s calculated insults to both China and the Koreas over the memory of its WWII atrocities when it invaded and occupied both countries.


But Bush, agree observers, is playing a precarious game; he needs the Chinese as much or more than they need him.  He recognizes that such grossly assymetrical trade relations cannot continue indefinitely, but that China has helped finance the growing US budget deficit.   At the same time, this two-edged sword is challening the US for supremacy in Asia.   Bush is steering a middle course;seeking to pressure but not alienate completely the leaders in Beijing.


 


 


 

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