Four weeks before, we had recounted in this column the coming tussle over the yuan and termed it as the biggest known unknown. What is known is that the lines have been drawn and it is a remote possibility that the ?Middle Kingdom? will be able to indefinitely stave off the pressure. What is unknown is when China will relent and how much the adjustment in the yuan will be.
During May, there have been four major developments. First, the US Treasury released its biannual report on exchange rates and trade, on May 17. Second, the Financial Times reported, on May 24, that the US Treasury had told the Chinese if they revalued their currency by 10% vis-a-vis the dollar, this would prevent protectionist US legislation. Third, following the release of the US Treasury report, the People?s Daily, the official newspaper of the Chinese communist party and government, reported that Premier Wen Jiabao had stressed (on Monday) that China would never yield to outside pressure on the exchange rate regime, saying any forex reform is a matter concerning China?s sovereignty. Finally, the EU and the US have initiated inquiries likely to result in safeguard restrictions being imposed on the import of Chinese textile products, which follow on huge increases in textile imports form China since January 2005.
So what is the protectionist legislation the Treasury was referring to? On February 3, Democrat Senator Charles Schumer moved a bill which set out that the yuan is undervalued by between 15% and 40%, giving Chinese exporters an unfair advantage, deleterious to US business and a violation of fair trade practices. Its operational part requires that if, within 180 days, China does not effectively revalue its currency, a rate of duty of 27.5% ad valorem shall be imposed on any article imported, directly or indirectly, from China. The bill was co-sponsored by Senators Hilary Clinton and Elizabeth Dole and 11 other senators, both Democrat and Republican. And on April 12, a bill was moved in the US House of Representatives by Republican Congresswoman Sue Myrick and co-sponsored by 31 others, both Rep-ublican and Demo-crat, which reads similar to the Senate bill and is identical in the crucial operational detail, about the imposition of 27.5% countervailing duties on Chinese imports, if China fails to revalue its currency within 180 days. Some time towards the end of July, these bits of legislation will come up and, if by then nothing happens on the yuan front, then given the broad-based bipartisan support, it is likely that push will indeed come to shove.
In response, the Chinese have put up a dour response. Prime Minister Wen Jiabao was quoted by the People?s Daily (May 17) as having said the Chinese government will never hastily take any action, regardless of the magnitude of pressure from outside. But since then, leading lights in the power structure of China, including Zhou Xiaochuan, governor of the People?s Bank of China (the central bank), have not dilated on the issue, leaving the job to obliging westerners scrambling for lucrative deals. The People?s Daily covering the 2005 Fortune Global Forum held in Beijing, quoted Kevan Watts, chairman of Merrill Lynch International Inc., as having said that the importance of the exchange rate of the yuan has largely been overstated. Stuart T Gulliver, chief executive of corporate investment banking and markets of HSBC, chipped in by saying that the timing for changing the currency exchange system should be when the Chinese authorities feel it right to make that decision. Of course, since the People?s Daily does not always use quotation marks, one does not know what exactly was said and how much was mind reading by the Daily?s reporter, or by someone on the editorial staff.
On May 26, the People?s Bank of China, was reported by the Daily as having reiterated that China will keep its currency ?basically stable at a rational equilibrium,? while improving the regime that determines the yuan?s exchange rate. What constitutes a rational equilibrium is, of course, something of more than passing curiosity. The most likely translation is status quo.
With respect to textile quotas, the People?s Daily has been kinder with the EU. It reported that a EU spokesperson claimed China and the EU could find a formula acceptable to both sides before the deadline, thereby avoiding the start of the emergency special protection procedure. Perhaps they believe that differences between the US and EU are large enough for China to arrive at a separate accommodation with the EU. If they do, they should rapidly disabuse themselves. One of the biggest gainers from an appreciation of the yuan, vis-a-vis the dollar, would be the euro. The euro would drop vis-a-vis the dollar and that would take the currency pressure off the backs of already hard-pressed euro zone economies.
Should the fact that China?s leaders have not dilated along the lines of sovereignty be interpreted as a realistic assessment that this is one faceoff China cannot win? Most likely not. This confrontation is likely to be a more complicated affair, not delinked from China?s opposition to Japan?s candidature to the UN Security Council and the spontaneous anti-Japan stone-throwing demonstrations recently. Or, for that matter, how China?s heavy hand rests so lightly on Kim Jong-il of North Korea, who, after sending missiles over Japan?s territorial waters, is busy making nuclear bombs.
There are other lesser complications, like 10% of China?s forex reserves being placed with its four state-owned banks. How they will absorb the loss arising from a yuan appreciation in their bright-red profit and loss accounts is as unclear as the economic consequences of the loss that will visit the central bank.
The writer is economic advisor to Icra