Dealing with exchange rate protectionism.

• Author: Schwartz, Anna J.

In this article, I first review protectionist allegations against China, particularly that its currency is undervalued and is being manipulated so that the renminbi (RMB) will not appreciate. Next, I discuss China's reasons for not changing its foreign exchange policies for the time being. Finally, I assess the U.S. position on the conditions it faces that have led it to pressure China to change those policies forthwith. In a postscript I mention what China must do before planning an exit from its present exchange rate regime.

The Complaint against China

Protectionism is expressed in two main forms: the traditional attack on a foreign country's trading practices, and the more recent attack on a foreign country's exchange rate policies. Both are a response to a deficit in the balance of trade with a foreign trading partner, but the first form of protectionism may be directed against a deficit in the balance of trade of a particular industry (e.g., steel or textiles).

The current prime target of protectionism is China. Previously Japan was the target. Complaints about China's trade practices allege that it is counterfeiting patented and copyrighted products, granting illegal subsidies on exports of agricultural products, and erecting non-tariff barriers against soybean imports. China in turn has faced restrictions on its textile exports under the Multi-Fiber Agreement. The Agreement expired at the end of 2004, and the prospect of larger textile exports by China in 2005 is leading textile manufacturers to demand "safeguard" provisions that importing countries obtained as one of the conditions for admitting China to the WTO.

The case for protectionist opposition to China's exchange rate policy is that it deliberately undervalues its currency to gain a competitive advantage for its exports. It is this policy in the view of the critics that contributes to the U.S. growing current account deficit. If the exchange value of the RMB were to appreciate relative to the dollar, Chinese goods would for a while become more expensive in the United States and its trade surplus with the United States would be reduced.

Since 1995 China has maintained its nominal exchange rate against the dollar within a narrow band at 8.28 yuan. (1) (The yuan is the unit of account. RMB translates as "the people's money.") Over the past two years China's real exchange rate has depreciated while a surplus in its balance of payments has strengthened. Its current account surplus in 2003 with the United States was more than $120 billion, much larger than its overall surplus with the world of $46 billion. Over the past decade capital inflows have produced a surplus in the capital account of about 4 percent relative to GDP, and a large inflow in 2003 in anticipation of expected appreciation of the renminbi. The current account surplus relative to GDP is something like 3 percent of GDP. In addition, China uses the surplus to purchase dollar assets. Its foreign exchange reserves, now more than $600 billion, have been accumulating over the past decade, and at a particularly rapid pace since 2003, suggesting that it is trying to hold down the real exchange rate. This is the ground for the charge that it is manipulating its exchange rate.

China's alleged currency manipulation has been the basis for the introduction of bills in Congress to impose a surcharge on its exports to the United States if it fails to end the practice. When U.S. Treasury Secretary John Snow visited Beijing last fall, he recommended that China immediately move to open its capital market and float its currency. John Taylor, Under Secretary of the Treasury for International Affairs, extended an invitation to China to attend a dinner meeting of finance ministers of the G-7 countries scheduled at the start of October 2004, with the implication that it might be admitted to the group provided that China ended its practice of pegging the yuan to the dollar. Treasury Secretary Snow was expected to press China on its currency at the dinner. It was anticipated that China would make some concessions on its currency at the October 1 dinner meeting of its central bank governor and finance minister with the G-7 country representatives. Instead, the Chinese officials told their U.S. counterparts that they intended to float or revalue the yuan without committing themselves to a date when the change would begin. Secretary Snow found the Chinese position unsatisfactory, but acknowledged that progress was being made. Earlier Taylor also had expressed the administration's satisfaction with the steps China had taken to prepare for making its currency flexible.

This sentiment was not shared by an alliance of American manufacturing companies and labor unions. They recently petitioned the Bush administration to sue China at the WTO for keeping the value of its currency fixed against the dollar. Although it is the IMF's responsibility to resolve international currency disputes, the petitioners asserted that they had turned to the WTO for a remedy because the IMF was not doing its job. The administration denied the petition. The response of the managing director of the IMF to the critics was...