Op-Ed Contributors

No winner in a currency war

By Xiao Gang (China Daily)
Updated: 2010-11-12 08:11

Shifting public debts to other countries, blocking Chinese investments and limiting exports will affect global recovery

It seems a wise decision by the Treasury Department of the United States to hold off releasing its semi-annual report to the Senate, thus delaying a decision on whether to brand China as a currency manipulator. There has been a nearly 2.6 percent rise in the value of the yuan against the dollar in recent months.

Although the currency conflict between China and the US is nothing new, and will definitely continue, it is very important for both sides that they find a way to achieve a win-win situation. The issue of currency management should not have been as highly politicized as it is.

It is clear that most of China's trade surplus comes from the processing trade conducted by foreign investment enterprises and joint ventures, and a revaluation of the yuan would do little to reduce the surplus or to help the US boost its economy.

US and European firms shift their factories to China and other developing countries because it is in their best interests to do so. It reduces labor and other costs and increases profit margins. It is this very simple economic incentive that drives firms to expand their businesses globally.

Profits from these overseas subsidiaries or joint ventures with local firms often contribute a large share of the bottom line of parent companies in the US or Europe, leaving them more profitable, more innovative, more job-creating and economy-enhancing in their home countries. In the midst of the global financial crisis, many US companies have relied largely on profits generated from the Chinese and other developing markets to weather the storm, enabling their home economy and employment to suffer less.

In other words, reducing China's trade surplus simply means shrinking the profits of these international companies, which is not only harmful to Chinese employment, but also to the US economy and US jobs.

Nobody denies that many emerging economies have been actively playing a part in the global supply chain for manufacturing and services, creating an explosion of wealth in the developed nations. Cheap products come not only from China, but from dozens of countries in Southeast Asia, Eastern Europe and Latin America.

Cheap imports from China have not been the cause for the decline of manufacturing output and job losses in the US. Even a significant exchange rate adjustment in China would not bring low-income jobs back to the US.

To achieve its double exports strategy in the next five years, the US should lift the ban on exporting hi-tech products to China. This is an effective way to boost US exports and reduce China's trade surplus.

The biggest force undermining the dollar is the US Federal Reserve, so it is high time for them to reconsider their exchange rate policy in rebalancing the US economy.

It was necessary two years ago for the US to take an unconventional monetary policy stance to address the crisis, but this time a second round of quantitative easing, or QE2 policy, seems dangerous. With the dollar's interest rates at nearly zero, the country is printing more money and pumping them into the US markets from where it flows to the rest of the world. As a result, the dollar has tumbled; inflation expectations have increased; asset and commodities prices have hit new peaks. Even worse, the dollar's depreciation has negatively affected other economies and currencies, forcing them to act, either by imposing capital controls or intervening in their exchange rates.

This is a "beggar-my-neighbor" policy. During the crisis, the US nationalized a lot of private debt, but in the post-crisis period, it is trying to internationalize its public debt. The policy is shortsighted, beneficial to neither US economic growth nor global recovery and stability. Shifting the accumulated debt burden across the world by softening the dollar will force other countries to take action to protect their currencies, and will ultimately isolate the dollar and its users. Therefore, the US needs to refrain from the QE2 policy.

Historical experience shows that policymakers must be cautious about aggressively shifting exchange rates as a means of economic rebalancing. Japan excessively revalued the yen according to the so-called Plaza Accord that was struck between five leading Western countries in 1985, but its exports softened, the asset bubble burst and there was decade-long deflationary stagnation.

Exchange rate reform is in the interests of China. Making the rate more flexible would also reinforce economic resilience. But what China is going to do is not simply reduce its exports by revaluing the yuan, rather, it will focus on more balanced foreign trade development without an over-dependence on the processing trade.

Strengthening general trade is imminent. It requires our domestic industries to enhance their innovation, manage their brands and improve their distributive channels in order to increase hi-tech and value-added exports. Unless general trade is predominant, instead of relying on the processing trade in foreign trade development, China will not become the biggest trade country in the world.

China will also persistently increase its imports. Chinese domestic markets have become an increasingly important part of the international market, inevitably intensifying competition. The domestic industries need to seize the opportunity and address the challenges by upgrading their products and services and creating more value for their customers.

Foreign trade is closely associated with overseas investments. Encouraging China's enterprises to go abroad would be directly translated into large, stable imports, so as to further improve the international balance sheet.

Only two years ago, economic necessity meant the US wisely chose to cooperate - quite smoothly - with China during the worst of the global financial crisis. Today politics is waging a currency war in which there can be no winner.

If the two countries could work well together before, why can't they now?

The author is Chairman of the Board of Directors of Bank of China.

(China Daily 11/12/2010 page8)