Pressure mounts on Chinese to float renminbi

Why the US and China are closer on currency than it might seem

As China puts up a strong show of resistance against the pressure from the United States to allow its currency to float, parallels are being drawn with what happened in Japan in the 1980s. Sooner or later, China will give in, as Japan did with the Plaza Accord, and allow its currency to revalue against the dollar.

China has been loudly denying this ever since the US Treasury Secretary, John Snow, paid a visit to Beijing earlier this month. Indeed, the Chinese authorities believe Mr Snow's remarks to be little more than electioneering by the Bush administration ahead of the presidential contest next year.

"Making China the scapegoat can perhaps help some US politicians score cheap political points, [but] it has nothing to do with the solution of their real problems," China Daily said.

"The high-pitched but groundless US objections against China's trade policies do not bear scrutiny," argues the People's Daily. "China's soaring exports were largely fuelled by drastic trade reforms, dynamic private and foreign-funded enterprises and an abundance of cheap and skilled labour instead of an undervalued currency". In the US some are claiming that the renminbi is undervalued by as much as 40 per cent and this is helping Chinese manufacturers destroy jobs by flooding the US with low-cost products.

The Bush administration, which has seen 2.7 million jobs disappear, is trying to increase the pressure on China to speed up access to goods and services spelt out in the deal that allowed China finally to join the World Trade Organisation 18 months ago.

US lawmakers from industrial states are pushing for legislation that would threaten China with higher tariffs if the country refuses to let its currency, the renminbi, float at market rates.

But behind the bluster from both sides and the trans-Pacific tensions over jobs and market access, the two countries are not as far apart as it might seem. It is clear something has to give. China is now running a $100bn (£60bn) a year surplus with the US, which is even bigger than Japan's.

In June China had foreign currency reserves of $365bn. In order to keep the renminbi stable at about 8.28 to the dollar, China's central bank has to keep buying up surplus dollars and reinvesting them abroad.

In practice this means buying US Treasury bonds. China's holdings of US Treasury bonds rose to a record $122.5bn last month, far more than any other country apart from Japan. Together Japan and China hold 41.9 per cent of the $1.35 trillion debt the US government owes the world.

Clearly this is unsustainable in the long run. It also means the Chinese government has to keep printing hundreds of billions of renminbi. As Chinese banks keep lending like crazy, this is helping to keep China's economy growing at more than 8 per cent a year.

The central bank does try to control the potential inflationary effects of this helter skelter expansion of the money supply by borrowing back much of the extra renminbi, but it is not an easy trick to pull off. In the mid-1990s when Beijing printed too much money it led to a destabilising bout of runaway inflation, but this time China is trying to avoid this by, in effect, exporting deflation to the rest of the world. This is helping to keep inflation under control, which means record low interest rates in America and Britain.

All this also explains why the rest of Asia grew by a meagre 3 per cent in the first half of 2003 but China recorded 9.9 per cent real GDP growth in the first quarter. It probably would have better in the second had Sars not stalled the economic engine. Even so, domestic demand is now shooting up at a 14 per cent annualised pace and imports are up by 50 per cent as China sucks in ever-growing quantities of oil, minerals, timber and other raw materials.

Domestic car sales have tripled and a furious construction boom is under way. The amount of residential floor space under construction grew by a third in the past 12 months alone. China is already the world's biggest steel maker and capacity will probably grow by 40 per cent in the next two years.

With the economy overheating like this, some are warning that a crash is only around the corner.

Overall, China is running only a small trade surplus. Many of its imports are parts from Taiwan, Japan or other countries which it assembles to make goods whose final destination is the US. Changing the value of the renminbi to make Chinese labour more expensive is unlikely to help protect jobs in the US although it might make a difference to some manufacturers, such as textile factories trying to hang on in Taiwan or South Korea.

"Since the eruption of the 1997 Asian financial crisis, the stability of the [renminbi] exchange rate has not only enhanced China's economic and financial stability, but also contributed to the financial and economic stability in the Asian region and rest of the world," China's finance minister Jin Renqing claimed in Dubai this weekend.

Behind the soothing talk of financial stability, Chinese officials also face the political imperative of creating new jobs at home. Tens of millions of jobs have been lost in the reform of China's bloated state sector during the past decade, leaving some 30 million unemployed in China's cities plus 100 or even 200 million underemployed in the countryside. Just to keep standing still China needs to create 15 million new jobs a year.

"The market-based, single, managed floating exchange regime as adopted by China complies with China's fundamentals," Mr Jin also maintained. China's fundamentals include a staggering burden of bad loans and uncovered pension and social welfare liabilities, which at more than $500bn even rival Japan's better-known debt burden.

It will take many years for China's four main state banks to shuffle off the crisis of non-performing loans. Many say Beijing has yet to begin in earnest. This means that China can only move slowly to lift the curbs on capital flows or risk seeing Chinese savers quickly pull their money out of the shaky domestic banking system. "There is no strong reason to have any kind of sudden changes," Zhou Xiaochuan, the chairman of the China Securities Regulatory Commission, insisted in Hong Kong last week, although he added that: "we're always going forward, making new changes".

Most observers assume China will slowly move to allow the renminbi to float and it will take small steps to allow Chinese to use their foreign currency savings and take money out of the country. This month, for example, China allowed individual tourists to apply for visas to Hong Kong and allowed each to take out 20,000 renminbi instead of 8,000.

The UBS forecaster Jonathan Anderson thinks that at best China will widen the renminbi-dollar band by 1-3 per cent in the immediate future as a result of US pressure. Full convertibility of the renminbi remains the official goal of the Chinese government but the timing remains as hard to predict as ever.