Two More Toxic Words
It would be funny how words seem to change their meaning were it not for possible serious consequences. For some years now, various American officials and others have accused China of currency manipulation. Treasury officials have not gone that far officially, but their rhetoric comes close. My friend, the new Secretary of the Treasury, has come too close on a couple of occasions, in my opinion.
I suppose you could define the term, "manipulation" to suit your argument, but that's not the cowboy way. We believe that words should keep their value and meaning as much as currencies. The simple, plain fact is that what some are now calling currency manipulation by China was considered official sound policy back when we did the same thing. Let me repeat: when they do it, some call it manipulation; when we did it, it was sound policy.
I refer, of course, to the postwar Bretton Woods System of fixed exchange rates, in effect from the late 1940s to the early 1970s. We promised to exchange dollars for gold at a fixed dollar price for foreign central banks and governments. The latter, in turn, used their dollar reserves to intervene in their foreign exchange markets to maintain a fixed exchange relationship within a very narrow band between their currency and the dollar. That system of pegging or fixing exchange rates was official policy. What we did then was what we call "currency manipulation" today.
I find it somewhat embarrassing that so many of us who should know better keep accusing China of doing wrong when it was considered doing right when we did it. Actually, I understate my case. China has allowed its peg to float up in recent years; so they have appreciated their currency in a methodical and orderly way. They've had a crawling band in recent years, allowing it to move up as we have urged. Their band, as I understand it, has also been allowed to widen, providing more market flexibility within limits.
Given China's large current account surplus and the large U.S. deficit, it probably is desirable for the yuan to strengthen and the dollar to weaken. But that is already happening and has been for some time.
With the global economic decline, some people have speculated that China might slow or end the upward drift of their currency to maintain competitiveness. I don't know. But I do recall that, in the Asian Crisis of 1997-1998, when many currencies were devalued, China played the role of statesman, responsibly holding the yuan steady, contributing to stability in the region.
So far, our Treasury has wisely avoided formal charges of currency manipulation against China. That's good. It would be even better if they would also avoid toxic talk in less formal circumstances.
As to the question whether the Chinese currency is currently undervalued, the market will provide the answer. If the market puts upward pressure on the Yuan, which requires Yuan purchases of other currencies to offset, then we might conclude it is undervalued. Whether it is undervalued against a particular currency like the Dollar is another question. The best we can probably do to answer it is to determine whether dollar weakness is closely correlated with Yuan strength and see how the bilateral trade balance is moving.
I'm not sure what to make of recent statements by Chinese officials denigrating the role of the dollars as the world's primary international reserve currency and reflecting some ambition for the Yuan in that role. It doesn't upset me.
Currency competition is a healthy benign thing as long as the competition is limited to providing strength through price stability and a healthy domestic economy. Having said that, I think the dollar will be paramount for some time to come. Challenges will only make the world economy better.