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News : International Last Updated: Feb 7, 2010 - 10:24:09 PM


China says currency exchange rate close to "reasonable" level
By Finfacts Team
Feb 5, 2010 - 4:27:42 AM

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China on Thursday rejected US criticism of currency exchange rate saying it is close to a "reasonable" level.

"We expect the United States to take a rational view of bilateral trade issues and to adhere to equality in negotiation. Accusations and pressure will not bring solutions,"Foreign Ministry spokesman Ma Zhaoxu said at a regular briefing. On Wednesday, President Obama said the United States had “to make sure our goods are not artificially inflated in price and their goods are not artificially deflated in price; that puts us at a huge competitive disadvantage.”

"Our currency, the renminbi, has appreciated more than 20% against the US dollar since July 2005, when China moved to a floating exchange rate regime,"Ma said on the depegging of the the renminbi from the US dollar at a fixed rate of 8.28. In three years, China's currency was allowed to gradually appreciate by 21% but in mid 2008, the rate was again fixed to help exporters.

"The renminbi exchange rate has drawn close to a reasonable and balanced level, given the international balance of payments and the market supply and demand for foreign exchange," Ma said.

Ma dismissed the notion the exchange rate is the major cause of the US trade deficit.

"China has never attempted to seek a trade surplus," Ma said, adding that China-US trade cooperation is mutually beneficial.

In 2009, China's foreign reserves increased by $453 billion to $2.4 trillion.

On Wednesday, Xinhua, China's official state news agency said Chinese economists were concerned that the American government, suffering from a record budget deficit, could print more dollars and issue more bonds, eroding the value of the dollar.

China held $790bn worth of US Treasuries in Nov 2009 and with other holdings, it is estimated to have two-thirds of its reserves in dollars. However, dumping dollars in the short-term would hurt itself.

“It will be like water off a duck’s back,” said Nicholas R. Lardy, a China expert at the Washington DC think-tank, the Peterson Institute for International Economics, in regard to US criticism, in a comment to The New York Times. “They’re puzzled by the criticism. They think they should be praised for keeping their currency stable at a time of global turmoil.”

In a book published last year, The Future of China's Exchange Rate Policy, Lardy and co-author Morris Goldstein, trace the recent history of Chinese practices and policies, reaching several conclusions. First, the origins of China's undervalued currency of the past 5–6 years lie in the decision of the authorities in the mid-1990s to fix the nominal value of the renminbi to the dollar. This policy was a great success for the first five years because the value of the dollar was appreciating and the nominal peg of the renminbi to the dollar meant that the Chinese currency was appreciating steadily on a real, trade-weighted basis. The pace of this appreciation, more than 3% per year, roughly offset the growth of productivity in China's tradable goods sector. Thus Chinese goods did not gain in international competitiveness, and China's external surplus from the mid-1990s through the early years of this decade averaged only 1–2% of gross domestic product.

But beginning in 2002 the dollar began to depreciate and China's nominal peg to the dollar meant that its currency began to depreciate in real effective terms. Productivity growth in the tradable goods sector continued, so the gap between China's equilibrium exchange rate and its real effective exchange rate began to widen. By mid-2005, when the currency reform was announced and China abandoned the renminbi:dollar peg, the gap between these two rates (one measure of undervaluation) was about 25%.

A second conclusion is that two years after the new currency policy came into force, the degree of undervaluation of the renminbi was actually greater than in mid-2005. Through late 2007 the cumulative real, trade-weighted appreciation of the renminbi was less than productivity growth in the tradable goods sector, so the degree of undervaluation deepened. In the process, the current account surplus soared from 1.3% of gross domestic product in 2001 to an astonishing 11% in 2007.

From November 2007 through the end of 2008, however, the pace of appreciation increased substantially. According to three alternative measures of the real effective exchange rate analysed in the study, half to three-quarters of the cumulative appreciation of the renminbi between July 2005 and the end of 2008 occurred in the period of November 2007–December 2008. The central feature of this conclusion is that the degree of undervaluation of the renminbi wasstill 15 to 25 percent on a real, effective basis.

To maintain its exchange rate, the People’s Bank of China extracts the excess inflow of foreign funds from the market and channels it into its foreign exchange reserve account. To sterilise, or mop up, this liquidity, the bank issues central bank bills.

SEE: Finfacts article, Feb 04, 2010: Obama raises issue of China's dollar-pegged currency at time of rising tensions

Impact on Developing Countries

In the Financial Times on Thursday, Arvind Subramanian, also from the Peterson Institute for International Economics, argues that a consequence of the global imbalance perspective is that it has created an opposition between current account deficit and current account surplus countries, which has become a slanging match between the US and China. But an undervalued exchange rate is above all a protectionist trade policy, because it is the combination of an import tariff and an export subsidy. It follows therefore that the real victims of this policy are other emerging market and developing countries -- because they compete more closely with China than the US and Europe, whose source of comparative advantage is very different from China’s. In fact, developing countries face two distinct costs from China’s exchange rate policy.

Subramanian says emerging market countries such as Brazil, India and South Korea are loath to allow their currencies to appreciate - - to damp overheating - - when that of a major trade rival is pegged to the dollar.

He says the emerging market victims of China’s exchange rate policy have remained silent because China is simply too big and powerful for them to take on and by default, it has fallen to the US to carry the burden of seeking to change renminbi policy. But it cannot succeed because China will not be seen as giving in to pressure from its only rival for superpower status. Only a wider coalition, comprising all countries affected by China’s undervalued exchange rate, stands any chance of impressing upon China the consequences of its policy and reminding it of its international responsibilities as a large, systemically important trader.

The story of the impact of Chinese imports on the production of the keffiyeh scarf, the symbol of Palestinian nationalism,  is an illustration of the impact on textile production in poor countries.

“Next time you come, it will be better, God willing,” Yasser Herbawi, the 76-year-old owner of the first and only Palestinian keffiyeh factory told the Guardian newspaper in 2008.

“It’s the Chinese imports,”explained Yasser, sitting amid piles of keffiyehs at the Herbawi factory storeroom, just outside Hebron in the West Bank. “In the 70s we could barely keep up with demand, but by the mid-90s cheap Chinese scarves started coming in, because of globalization and GATT.” Yasser’s sons Abdel Atheem, 50, and Judeh, 43, nod in agreement and curse the trade tariff-busting deal. “We were forced to lower our prices and today we are working to a fraction of our capacity because we cannot compete.” The factory used to produce more than 1,000 scarves a day, but now makes less than 100 -- and struggles to sell those. A shutdown seems almost inevitable.

VIDEO: French journalist Benoit Faiveley visits the last Palestinian keffiyeh factory in Hebron on the West Bank.

China uses some of its reserves to build commodity supply chains across the world and last July, Wen Jiabao, the country’s premier, said Beijing will use its foreign exchange reserves to support and accelerate overseas expansion and acquisitions by Chinese companies.

The FT reported that in an interview published in state-controlled media, the chairman of China Development Bank said Chinese outbound investment would accelerate but should focus on resource-rich developing economies.

“Everyone is saying we should go to the western markets to scoop up [underpriced assets],” said Chen Yuan. “I think we should not go to America’s Wall Street, but should look more to places with natural and energy resources.”

John Griswold, of Commonfund, and Peter Navarro, of U.C. Irvine, discuss whether the US is headed toward a trade war with China:

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