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Debate Over Value of Yuan Heats Up in Washington

The long-running debate over the value of China’s currency is heating up in Washington. Last week, senators from both parties introduced a bill that would compel the Obama administration to confront China over the undervalued yuan, which many economists believe China keeps artificially low to give them an export advantage.

The House Ways and Means Committee meets Wednesday on the issue. Likely on the agenda will be the upcoming April 15 deadline for the Treasury to declare China a currency manipulator in its biannual report to Congress on trading partners and the recent criticism of China’s business environment by a top official at the U.S. Chamber of Congress. Chinese CEOs are even coming out in favor of yuan appreciation — even as the government denies it is undervalued — saying it would lower import costs and allow the market to set interest rates.

For a sense of the stakes in the currency debate and possible outcomes if the United States takes a bolder stand against China, we spoke to Nicholas Lardy, senior fellow at the Peterson Institute for International Economics and an expert on the Chinese economy.

What’s the currency debate about?

NICHOLAS LARDY: When people accuse China of manipulating its currency, what they have in mind is the government has engaged in large scale intervention in the foreign exchange market to keep its currency from appreciating. This is reflected in the fact that China’s foreign exchange reserves grew $450 billion last year to reach $2.4 trillion. So China’s reserves are far and away bigger than any country as ever had in history. And they have increased more rapidly than any other country in history.

It affects global trade by making China’s goods around the world less expensive and foreign goods in China more expensive. That means China runs a large trade surplus. China’s trade surplus as a share of GDP is the largest trade surplus any country has ever had.

Legislation [like that currently in the Senate] has been introduced before. What’s different now?

NICHOLAS LARDY: I think several things have changed.

First, the Chinese, when they introduced a new currency regime in 2005, said that the value of their currency – and this is a quote from them then – would be ‘increasingly determined by supply and demand in the market.’ And quite frankly, Sen. [Charles] Schumer and his colleagues who have introduced legislation previously may have felt that the threat of extreme congressional reaction then helped to push the reform process in China. Almost 5 years later, after [the Chinese] have built up even more foreign exchange reserves, Schumer and others may feel they were sold a bill of goods.

Second, back when these policies were first discussed in 2003 and 2004, we had something closer to full employment and economic growth was rapid. Today, we have high levels of unemployment, as do other countries, and China’s trade surplus is even bigger. The feeling is that this imposes more costs on the rest of the world than it did four or five years ago.

The Treasury is also about to release its biannual report to Congress on the currency policies of U.S. trading partners, and it must decide whether to label China a currency manipulator. Is there any sense of whether that will happen?

NICHOLAS LARDY: Most people have forgotten this, but the Treasury did name China a currency manipulator twice in 1993 and 1994, when Larry Summers was Treasury secretary. There is a lot of speculation they might do so now. There appears to be a lot of internal debate in the administration.

Should Treasury take that step, what are the likely political and business ramifications?

NICHOLAS LARDY: The immediate ramifications are extremely modest because under the terms of the legislation that generates this requirement, all the Treasury is required to do is enter into discussions with the country that is manipulating. And Treasury has been discussing currency manipulation with Chinese officials for six or seven years. This would not make a big difference.

But politically, there will be ramifications. China very much does not want to be named a manipulator. They probably would huff and puff and make complaints. But I doubt that they would take any retaliation other than verbal. But if some of the provisions in the Schumer and [Sen. Lindsey] Graham bill take effect, they might act.

They won’t [start selling off their holdings of U.S. debt]. They don’t have any leverage. Selling off their assets of U.S. dollars will hurt them more than it will hurt us. So, they probably will not react that way.

Any retaliation would come in trade sphere, with regulatory changes and other things that would make it harder for U.S. companies to do business in China.

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