As controversy surrounding China’s undervaluing of its currency increases, the Senate Finance Committee in the US, in its semi-annual report, has said that Beijing did not meet the criteria to be called a currency manipulator. (If it had then it would have ben subject to trade sanctions from the US).
It claimed that there has been progress over this contentious issue with a 15% improvement in its valuation.
The Treasury claims that the Chinese authorities have reduced the level of intervention dramatically in exchange markets since the later part of 2011.
Since 2005 China has had a managed economy, pegged against a basket of foreign currencies. However, the US has claimed that China has taken steps in the right direction to liberalise controls on capital movements and thus eventually move towards a more flexible exchange rate.
Nevertheless, Chinese authorities have sought to use their competitive advantage in cheap exports to increase demand for Chinese goods after the economic crisis. However, there are many negative consequences of having an undervalued currency as well. Firstly most Chinese households’ buying power will be diminished and secondly there isn’t much pressure, via competition, for companies to develop more innovative products, which not only improve quality of life but also create many jobs.
Some Chinese economists have suggested that China could find better uses for the hundreds of billions of dollars it spends buying United States Treasuries and other foreign securities to keep the renminbi from rising against the dollar. This has an underlying tone of a threat towards the US, which may have been a reason why Obama recently stopped short of labeling China a currency manipulator, despite popular dismay internally at the very cheap currency.
This therefore highlights the catch 22 that the US and China appear to be caught in – The US needs to maintain a good relationship with China to preserve its money supply especially America’s debt, of which China is the largest foreign holder of. Similarly, China needs cooperation with the US due to its crucial market for Chinese goods – the US being China’s single largest exporting destination and thus plays a significant role in Chian’s economic growth and stability.
Consequently both sides are being cautious not to strain this dependent relationship. Thus the US doesn’t want to appear too harsh on China’s undervaluation whilst at the same time China realizes that it is attracting too much negative attention globally and thus needs to address this. But to what extent it will do this remains to be seen.