No Thaw Looming in U.S./China Relations

The Bush Administration wants to head off more protectionist action from Congress, and there seems to be an informal quid pro quo. Senators Schumer and Graham again postponed their punitive bill (until September, at least) and the Treasury officials have escalated their rhetoric and pressure on China.

Both Treasury Secretary Snow and the under-Secretary Adams claimed in recent weeks that China could adopt a more flexibly currency regime, that the institutional framework exists, but what is lacking is political will. In the newly released national security strategy the renminbi's value was identified as a security issue. There is little doubt after a respectable period of time after President Hu visits the U.S., the Treasury Department will cite China as a currency manipulator.

China, of course, will protest such a designation. How can a peg, which is no longer a peg, be considered manipulation? The renminbi was pegged to the U.S. dollar when the dollar was strong in the second half of the 1990s and when the dollar was weak in the last half decade. That is the beauty, if you will, of the Grassley-Baucus bill that will shift the focus from currency-market manipulation to currency misalignment.

But misalignment begs the question: What is the appropriate value and who determines it? For all the lip-service paid to the benefits of exchange rates being determined by market forces, many U.S. and Japanese officials would be content with a sharp appreciation of the renminbi and allow China to then develop a more market-based exchange rate policy at its own leisure.

After all, markets are a little like a democracy. Once in place, it is hard to control the outcome. Similarly, letting the renminbi float with open capital markets could very well see the renminbi fall. The hot money betting on a revaluation would take their money out and look for another play. International businesses, which account for about half of China's manufacturing exports, would find it easier to repatriate their earnings from China. In addition, the growing economic elites, like the elites in other developing countries, would likely take some of their wealth and put it offshore.

China is likely to announce a wider band for the renminbi against the dollar. Currently it is allowed to move in a 0.3% band, and even that 0.3% band is not being fully explored. Remember under Bretton Woods, a 1% band was regarded as fixed. Therefore, widening the band to, say, 2.5% or 3% would be a low-cost concession for China, especially if only a small part of the new band is explored.

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