China, America and the yuan

Over to you, China

America has dampened a currency row with China. Now Beijing must let the yuan rise

IT DID not win him friends in Congress, but Tim Geithner, America’s treasury secretary, was right to postpone a decision, due by April 15th, on whether or not to declare China a currency manipulator. By putting off the release of a semi-annual report on China’s exchange rate he defused, at least temporarily, Sino-American tension over the value of the yuan, which has been pegged tightly to the dollar since July 2008. Even better, he did so in a way that maximises the odds of a resolution of the currency problem.

Chinese policymakers now have several months to allow the yuan to strengthen without appearing to be caving in to bilateral American pressure—no small consideration, given China’s fierce nationalist sensitivity. Mr Geithner also tried to shift the terms of the debate away from bilateral threats, by making clear that forthcoming multilateral meetings, especially those of the G20, are the right places to discuss China’s currency. And his willingness to stand up to domestic political pressure (130 congressmen had sent him a letter demanding immediate action), set a good example to policymakers in Beijing. To be sure, the decision was not driven only by economics. America’s administration wants China to support tough sanctions on Iran, for instance. But the economic diplomacy was deft. America has shown it can behave responsibly. China must now do the same—by allowing the yuan to rise.

A stronger yuan would not just avoid a trade war between America and China. It would also help China by rebalancing its economy towards domestic consumption and making it easier to control inflation by giving China’s central bank a freer hand to raise interest rates. With consumer prices accelerating, that is becoming more urgent. Not surprisingly, China’s central bank is the main internal proponent of reform. But this week a senior government economist also hinted at a coming shift.

Opponents of a stronger yuan argue that the country can ill-afford to harm job-creating exporters, especially since much of the recent credit binge from government stimulus benefited capital-intensive heavy industries which create relatively few jobs (see page 81). But China’s economy is disproportionately skewed to heavy industry in part because of its undervalued exchange rate. A stronger currency would, by reducing the price of imports, increase Chinese households’ purchasing power and favour non-traded businesses such as services, which tend to be labour-intensive. That alone will not be enough to rebalance China’s economy. All manner of structural reforms, from corporate governance to taxes, are also needed. But a stronger currency would be a good start.

Now’s the time

Although domestic matters are higher on the Chinese government’s agenda, the external benefits of currency appreciation are not to be sniffed at. America is the loudest complainant, but it is other emerging economies, such as India and Brazil, that suffer most from the cheapness of China’s currency. So far, their governments have stayed remarkably quiet, but that is unlikely to last, especially if the yuan becomes a focal point of the G20 discussions.

Judged by its official trade rules, China is more open than most big emerging economies, but its hidden subsidies and barriers are legion, and recent actions, such as new government-procurement rules that favour domestic producers, point in the wrong direction. Trade disputes with China are spreading across the globe. Given the country’s growth and economic heft, that is probably inevitable. But allowing the yuan to appreciate would allow China to appease its trading partners at the same time as helping itself.