China’s Currency Manipulation: A Policy Debate

Blaming China is Tempting—but Wrong

China continues to confound America. Since its inception six years ago, the Strategic and Economic Dialogue between the US and China has served the very useful purpose of elevating one of the world’s most important economic relationships to the high level it deserves. Much has been accomplished, but further progress cannot be taken for granted, particularly if a fixation on the currency issue continues to dominate the economic agenda between the United States and China.

This fixation has arisen out of the combination of bad economic advice, a tough climate for American workers, and a politically motivated blame game. Congress has led the charge by repeatedly considering legislation aimed at the alleged threat of a cheap Chinese currency. Bipartisan support for such a measure initially surfaced when Senators Charles Schumer (a liberal Democrat from New York) and Lindsey Graham (a conservative Republican from South Carolina) reached across the ideological and party divide to co-sponsor the first Chinese currency bill in 2005. Over the years, the drumbeat for such a confrontational approach has only grown louder. By overwhelming bipartisan majorities, the House of Representatives passed a modified version of this bill in September 2010 and the Senate followed suit in October 2011. Fortunately, neither bill became law.

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Confront China’s Currency Manipulation Now

Political leaders may want to engage Beijing, but given its blatantly unfair trade practices, human rights abuses, and military aggression, a confrontation is long overdue.

The argument for legislative action against China rests mainly on America’s gaping trade deficit, widely thought to be a principal source of the acute pressures bearing down on US jobs and real wages. Indeed, a loss of market share to foreign competition does squeeze America’s companies and their workers. The US merchandise trade deficit has, in fact, averaged 4.4 percent of GDP since 2005—the largest and most protracted external gap in modern US history. Moreover, China has accounted for thirty-five percent of the shortfall over this seven-year interval, by far the largest portion of the overall US trade deficit. The anti-China critics claim that Beijing’s inroads into American markets are built on a blatant strategy of currency manipulation that is restraining the renminbi, or yuan, from rising to its “fair” market-determined value. A broad coalition of politicians, business leaders, and academic economists insists that the Chinese must revalue immediately or face punitive compensatory sanctions to level the competitive playing field.

This position resonates with the American public. Opinion polls conducted in 2011 found that sixty-one percent of the citizens sampled believe that China represents a serious economic threat. Indeed, the currency debate is potentially incendiary enough to become a major issue in the upcoming US presidential campaign. President Obama has drawn a line in the sand, replying, “Enough is enough,” when asked about the issue after his last meeting with Chinese President Hu Jintao. Mitt Romney has gone even further, promising to declare China guilty of “currency manipulation” the day he takes office as America’s next president.


However appealing the argument that China could fix our economic problems may appear to be, it is wrong. Currency adjustments—in effect, altering the relative prices between nations—are simply not the panacea that most economists once thought they were. Why? Several reasons come immediately to mind.

First, despite China’s outsize impact on our economy, America’s trade deficit is multilateral: the United States ran deficits with eighty-eight nations in 2010. Trying to fix a multilateral imbalance by putting pressure on a bilateral exchange rate is like squeezing one end of a water balloon: it will merely redirect that portion of the trade imbalance elsewhere—quite conceivably to a higher-cost foreign producer. In other words, this strategy would backfire; it would be the functional equivalent of imposing a tax hike on hard-pressed middle-class US families.

The primary sources of our multilateral trade imbalance are hardly a secret. First, there has been an unprecedented shortfall of national saving. America’s so-called net national saving rate—the combined depreciation-adjusted saving of individuals, businesses, and the government sector—fell into negative territory in late 2008 and has remained near or below zero ever since. Never before has the world’s leading economic power run a negative net national saving rate. Lacking in savings but wanting to grow, the US must import surplus saving from abroad—and run massive current-account and multilateral trade deficits in order to attract the foreign capital. That’s where China and our other eighty-seven trade deficits come in.

But politicians choose to blame others for our sins—specifically, those arising from unprecedented budget deficits and sharply reduced personal saving, the combination of which has forced the United States to turn to foreigners to fund domestic growth. Pointing the finger at China is not only simplistic but also dangerous in that it deflects attention from what is really required for meaningful economic recovery. Rather than inventing enemies, America should be dealing with the enemy within. If we don’t want trade deficits—with China or with anyone else—we must face up to our chronic shortfall of saving. If we don’t want to save, then we have to accept trade deficits as a steep price to pay for our profligacy.

A second reason that the China-focused blame game doesn’t work is that the renminbi has now appreciated 31.4 percent against the dollar since mid-2005, when China started to reform its foreign exchange regime. That’s well in excess of the 27.5 percent increase called for by the original Schumer-Graham bill. In other words, the currency hawks have pretty much gotten what they wanted. Meanwhile, the problems bearing down on American workers have only become worse. Against that backdrop, it is hard to argue that Chinese currency appreciation is a panacea for all that ails America.

Yet the position of many leading academics continues to be that China should have moved quickly with a large one-off adjustment to bring its currency to fair value. But the Chinese have long viewed such a move with trepidation—and with good reason. The painful lessons of Japan, especially its disastrous concession on sharp yen appreciation that was the centerpiece of the so-called Plaza Accord of 1985, provide a strong note of caution. The Chinese have opted instead for a gradual revaluation. The endgame is not in doubt. Recent moves toward the offshore internationalization of the renminbi, a more open capital account, and significantly wider currency trading bands leave little doubt that China is committed to establishing a market-based, fully convertible renminbi. Rather than fixate on the speed of the journey, we should draw comfort from China’s acceptance of the ultimate destination.

A third reason for the China-bashing comes from those who have strenuously insisted that it is in the world’s interest for Beijing to reduce its outside current account imbalance and use the currency lever to accomplish that critical task. The Washington consensus believes that global imbalances—an ever-present threat to the world economy for the past couple of decades—have been largely made in China, stressing that that country’s so-called saving glut has been a major source of global instability. Without a sharp renminbi revaluation, the argument goes, a crisis-prone world will never come to grips with its dangerous imbalances.

Here again, the political expedience of the blame game has obscured important elements in this debate. First of all, there has actually been significant improvement in China’s external imbalance. The International Monetary Fund estimates that China’s current-account surplus will narrow to just 2.3 percent of GDP in 2012, after peaking at 10.1 percent in 2007. Unfortunately, it’s hard to say the same for any meaningful improvement in America’s gaping external imbalance. By the IMF’s reckoning, the US current-account deficit is likely to be about $510 billion this year—fully 2.8 times greater than China’s surplus. Clearly, an unbalanced US economy has been—and continues to be—a major source of instability in a crisis-prone world.

Finally, China’s role in the global economy has changed considerably over the past thirty years. Specifically, it has evolved from the “world’s factory” to more of an assembly line. Research shows that no more than twenty to thirty percent of Chinese exports to the US reflect value added inside China. Moreover, roughly sixty percent of Chinese exports represent shipments of “foreign invested enterprises”—in effect, Chinese subsidiaries of global multinationals. This raises important questions about the identity of the fabled Chinese export machine: Is it them or us? (Think Apple.) The supply-chain logistics of globalized production platforms distort bilateral trade data between the US and China, and have little to do with the exchange rate.


In short, the Chinese currency is not the villain that it has often been made out to be over the past seven years. Rather than portraying China as the principal economic threat to America, the relationship between the two countries needs to be recast as an opportunity. That is particularly the case in a weak US growth environment, when Washington is looking for new answers.

The first step is a frank assessment of America’s growth quagmire. As a result of the recent financial crisis—and the years of excess that preceded it—our growth calculus has been turned inside out. Over most of our modern history, we have relied on internal demand as the engine of economic growth and prosperity. That approach is now in tatters. The largest component of US aggregate demand—the consumer—is pulling back as never before. With households focused on the post-crisis repair of severely damaged balance sheets, inflation-adjusted private consumption has expanded at an anemic 0.7 percent average annual rate over the past eighteen quarters. Moreover, consumer deleveraging has only just begun, suggesting these headwinds are not about to subside. With seventy percent of the economy on ice, the US is in desperate need of new sources of economic growth and job creation.

Exports top the list of possibilities—a view underscored by Nobel Prize–winning economist Michael Spence in a recent comprehensive study of America’s job challenge. In fact, the adaptable US economy may already be rising to the challenge. Merchandise exports have now risen to a record of nearly ten percent of our GDP—up dramatically from the six and a half percent share prevailing a decade ago. According to the Department of Commerce, US exports supported fully 9.7 million American jobs in 2011—up 1.2 million from 2009. In an era of unacceptably anemic job creation, this figure is especially impressive.

The Obama administration has set the ambitious goal to double US exports in five years. But with trend export growth to our largest external markets—Canada and Mexico—hovering at close to three percent over the past five years and stagnation long evident in Japan and now likely in crisis-torn Europe, America’s export agenda will need to turn to new markets.

China could well hold the key in meeting this challenge. It is now America’s third-largest and most rapidly growing export market. There can be no mistaking its potential to fill a growing portion of the void left by US consumers. Rather than dwell solely on the currency, Congress should turn its attention to how the US can tap the coming growth in Chinese domestic demand.

The key to this opportunity lies in market access—specifically, access to China’s future sources of economic growth. This is precisely the time to focus on this issue—as China’s own growth imperatives shift away from exporting into weakened US and European consumer markets toward satisfying the demand for its own 1.3 billion consumers. Unlike Japan, modern Asia’s first growth miracle, China is far more likely to satisfy this incremental consumption growth from foreign production. Chinese imports have been running at twenty-eight percent of GDP since 2002—nearly three times Japan’s ten percent import ratio during its high-growth era (1960 to 1989). As a result, for a given increment of domestic demand, China is far more predisposed to draw on foreign production.

As the Chinese consumer emerges, demand for a wide variety of US-made goods—ranging from new-generation information technology and biotech to automotive components and aircraft—could surge. And this plays very much to America’s competitive strengths: capital goods and motor vehicle products currently account for forty-two percent of total US goods sold abroad—our largest export category. The key for US trade negotiators is to make certain that leading American exporters have fair and open access to these new and potentially enormous Chinese markets.

A similar opportunity is available in services. At just forty-three percent of GDP, China’s services sector is very small when compared with other major economies in the world. Services are, in many respects, the infrastructure of consumer demand, and the Chinese services share of its economy will only grow in the years ahead. By contrast, the United States is the world’s quintessential services-based economy, with much in the way of process design, scale, and managerial expertise to offer China. There is enormous scope for America’s global services companies to expand and partner in China, especially in transactions-intensive distribution sectors—wholesale and retail trade, domestic transportation, and supply-chain logistics, as well as in the processing segments of finance, health care, and data warehousing. The recent Strategic and Economic Dialogue made significant progress in opening up Chinese financial services to increased foreign investment. Nonfinancial services now need attention, as well.

The US-China trade agenda must be refocused toward expanded market access in these and other areas—pushing back when necessary against Chinese policies and government procurement practices that favor domestic production and indigenous innovation. Some movement has occurred, but more is needed—for example, getting China to sign the World Trade Organization’s Government Procurement Agreement. At the same time, the US should reconsider antiquated Cold War restrictions on Chinese purchases of high technology–intensive items.

Important progress was made on both of these counts at the recent Strategic and Economic Dialogue meeting in May; the focus must now shift to follow-through, implementation, and enforcement. These breakthroughs could have critical implications for the Chinese piece of America’s export-led growth and employment agenda.

The bottom line for a growth-starved United States should be clear insofar as America’s economic relationship with China is concerned. The opportunities of market access far outweigh the misperceived perils of the currency threat. The time has come to de-emphasize the latter and focus on the former. The long-dormant Chinese consumer is about to be unleashed, providing new markets for all the world’s major exporters. This plays to one of America’s greatest traditional strengths—the zeal to compete and win share in new markets. Shame on us if we squander this extraordinary chance.

Stephen S. Roach is a senior fellow at Yale University’s Jackson Institute of Global Affairs and the former chairman of Morgan Stanley Asia. This article has been adapted from Senate testimony he presented in May 2012.

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