Currency Problems Between the United States and China

The currency issue is threatening to become a bone of contention between the United States and China. The Americans are criticizing the Chinese for a lack of flexibility in their Yuan currency and are worried about China’s enormous and growing foreign exchange reserves. The Chinese are complaining about the painful decline in the value of their accumulated U.S. dollars.

Just one month before U.S. President Barack Obama’s first state visit to China, Washington is taking a risk in publicly criticizing Beijing’s monetary policy. The U.S. Treasury Department is accusing China of a lack of flexibility of the Yuan in the current global crisis. The growing foreign exchange reserves in the People’s Republic are also worrying the Treasury Department.

A few days ago the Chinese Central Bank announced that its foreign exchange reserves, already the world’s largest, have increased once again. According to statements from statisticians, these reserves grew by $141 billion in the third quarter to a record high of $2.3 trillion. The Treasury Department’s semi-annual Report to Congress on International Economic and Exchange Rate Policies claims these growing reserves are threatening to damage the progress with exchange rate issues during recent years.

Large foreign exchange reserves are significant for imbalances in global trade. For years, the United States has accused the Beijing government of using an artificially maintained low Yuan exchange rate to create competitive advantages for its own export economy in the global market place. The recent Treasury report says this is why the Obama administration is demanding an explicit upward revaluation of and more flexibility in the Chinese national currency.

In 2005, Beijing officially dropped its policy of linking the Yuan to a fixed exchange rate against the U.S. dollar. Nevertheless, the Yuan still continues to be linked with the dollar in practical terms. Until July 2008, China had been taking small steps to revalue its currency upward by more than 20 percent relative to the dollar, but this was not enough for the Americans. However, at the beginning of the financial crisis, Beijing stopped this policy and has ever since kept the exchange rate essentially stable.

Even so, it was obvious that overly critical comments were conspicuously absent in the Treasury report to Congress. The report emphasized that no trading partner of the United States was illegally manipulating its currency. At the beginning of the year, shortly before his confirmation as Secretary of the Treasury, Timothy Geithner unleashed a chorus of outrage on the Chinese side with just such an accusation. Beijing rejected the charge as being “untrue and misleading” and said China never manipulated its currency to create advantages for itself in international trade.

On Friday, Chinese media outlets highlighted the positive aspects of the Treasury report. The Global Times headline was “USA Clears China of Currency Manipulation.” However, neither the Chinese Foreign Ministry nor the Central Bank commented on the issue. Even the American Chamber of Commerce in Beijing, at other times known for pointed comments, refrained from making an assessment.

More direct words came from the Asian Development Bank (ADB). An upward revaluation of the Chinese currency is not desirable. “We should not push hard for China to appreciate the currency too fast,” said Yolanda Fernandez Lommen, chief economist for the ADB in Beijing. “We don’t want to see China, the third largest economy in the world, unstable.”

Even the Bush administration had never accused China specifically of currency manipulation. After the Geithner criticism, Obama’s team omitted any reference to the delicate issue of monetary policy in conversations with Beijing. The president is focusing on a close economic collaboration with China. At the end of July in Washington, Obama emphasized that “the relationship between the United States and China will shape the 21st century.”

The Chinese government is certainly worried about the decline of the dollar. Beijing has approximately $800 billion directly invested in U.S. government bonds. In an unusual step in March, Premier Wen Jiabao publicly urged the U.S. government to guarantee that these investments will maintain their value. China’s President Hu Jintao had emphasized, furthermore, at the G-20 summit in Pittsburgh at the end of September that the “major reserve currency issuing countries should take into account and balance the implications of their monetary policies for both their own economies and the world economy.”

China is now trapped in a dilemma thanks to its large dollar holdings. On the one hand, the loss in value of the greenback diminishes the value of its own investments. On the other hand, the losses would increase further if the Chinese currency were revalued upward because the conversion of dollars into fewer Yuan would be reflected in government budget numbers. Nevertheless, analysts in Beijing are expecting a more agitated tone between China and the United States in questions of finance and trade.

To get out of the “dollar trap,” China has been getting more serious in attempting to diversify its foreign exchange reserves. Like all central banks, the trend toward diversification for the central bank in Beijing will be a similar move away from the dollar. That is why new reserves are being spent more on commodity purchases or are now being invested in things like the U.S. real estate market or the British beverage giant Diageo.

In recent months, on numerous occasions, China has been presenting itself as a new player on the international financial scene. It launched attacks again and again on the dollar as the key reserve currency. For example, the Chinese State Councilor Dai Bingguo demanded a diversification of the international monetary system at the G-8 summit. He said “we should improve the international monetary system and the issuance regulation mechanism of reserve currencies.”

Observers are convinced the weak dollar and the Yuan exchange rate will be up for discussion during Obama’s visit to Beijing in November. But Ben Simpfendorfer, an economist for the Royal Bank of Scotland in Hongkong, is one observer who is confident the Chinese government will not allow itself to be intimidated. This time China will just let the call for an upward revaluation of the Yuan fade away.