Keep your (made-in-China)
shirt on ... By Brian Wingfield
WASHINGTON - At a
breakfast with reporters on Wednesday, Charles Schumer, a
Democratic senator from New York, declared that
China "does not play
by the rules". The country's currency, which is
pegged to the US dollar, is undervalued, he said,
and Beijing should revalue it immediately. The
Chinese government, for the moment, has refused to
do so, prompting the senator to flatly state:
"China wants the advantages of free trade and not
the responsibilities."
Schumer has been
one of the most vocal US critics of China's
monetary policy, arguing that the undervalued yuan
makes Chinese exports exceptionally cheap in world
markets. The evidence? Chinese textiles have
surged in American markets by as much as 1,500%
since global trade rules were changed on January
1. In April, Schumer and Lindsey Graham, a
Republican senator from South Carolina, introduced
a bill that threatens a 27.5% tariff on all
Chinese imports to the US if China does not
rethink its monetary policy within six months.
The Schumer-Graham proposal is one of
Washington's loudest shots yet in the increasingly
tense Sino-American trade relations. The threat,
of course, is that a deterioration in these
relations could erupt into a full-on trade war,
with each side imposing protectionist import
restrictions on the other. If the actions of the
past few weeks are any indication, the two
countries are headed that way. On May 13, the US
launched a virtual weeklong assault on China's
economic policies. That day the Commerce
Department announced that it plans to impose
"safeguard" restrictions - permissible under
global trade rules - on three categories of
clothing and textiles from China, noting that the
absence of quotas within the past five months has
disrupted American markets.
Four days
later, Treasury Secretary John W Snow testified
before Congress that China's currency regime has
become "highly distortionary". His written report
to Congress that day stated: "China is now ready
to move to a more flexible exchange rate and
should move now." The next day, the Commerce
Department slapped safeguard measures on four more
categories of Chinese clothing and apparel
imports. The emergency quotas will go into effect
after Washington and Beijing have had a formal
consultation on the matter, to be scheduled
sometime next month.
The European
Union has also jumped into the fray. In April, the
EU began an inquiry into textile dumping by
China, and on May 17, Peter Mandelson, the EU's
trade chief, publicly called for China to curb
its textile exports. Six days later, the
Union's member states announced that they would soon
hold consultations with Beijing in an effort to
stem surging imports of T-shirts and flax yarn.
Then, on Wednesday, the EU said that China has until the
end of the month to decrease textile exports to
Europe or face restrictive quotas within the next
few weeks.
In spite of the twin assaults
on its economic policies, the Chinese government
has not really fired back. Instead, Beijing has
used a deft blend of rhetoric and action to keep
its critics at bay, at times playing the victim to
arm-twisting foreigners (as when, for example,
Chinese minister of commerce Bo Xilai complained
at a Paris meeting in early May, "China needs to
export 800 million shirts in order to buy one
Airbus A380"). Regarding the currency issue,
Chinese Prime Minister Wen Jiabao remarked on May
16 that his government "will take the initiative
to advance the reform of the exchange rate without
any pressure from outside". However, just a few
days later, China began to allow its banks to
begin a new foreign exchange trading system that
deals in eight currency pairs. This long-planned
move has been seen by some observers as a step
toward currency revaluation.
On
the trade issue, Beijing has taken a
similar stance. Commerce Minister Bo said that under a
World Trade Organization agreement, the US and EU
have had years to phase out their quotas, but
waited until only recently to remove them. "[This
delay] caused the short-term rapid growth of
China's textile exports in the first several months of
this year," he said. Yet, last Friday, the Chinese
government announced that it would raise export tariffs by
as much as 400% on 74 types of textile
products beginning June 1. Beijing said it made the
move "independently and voluntarily", but it
was largely seen as an act of appeasement
to Washington and Brussels. On Monday, however, the
Ministry of Commerce said it might retract some of
those newly announced tariffs should the Americans
and Europeans follow through with their threats to
impose safeguard quotas.
Several questions
beg to be answered: Is China really abusing its
competitive advantage, or is it being victimized
by the US and the EU? Is a trade war imminent?
Should China revalue the yuan, and if so, how
should it do this? Perhaps most importantly, who
wins and who loses from all of this?
On
the surface, it seems the trade problem is really
just a symptom of a much larger concern - China's
undervalued currency. However, there are two
separate - but linked - issues here: monetary and
trade policy. The fact that they have each reached
boiling point is perhaps the reason for the recent
saber-rattling, and a closer look at both of them
helps reveal the answers to the questions at hand.
The back story: Exchange
rate The monetary story
began in 1995, the year the yuan was first pegged
to the dollar at a rate of 8.28 to one. This
fixed rate - established before China became a global economic
powerhouse and before it joined the World
Trade Organization (WTO) - was intended to give the country
monetary stability. To maintain this exchange rate,
China accumulated foreign exchange reserves, mainly
US Treasury bills. But in 10 years,
much has changed. China's economy has grown substantially -
a whopping 9.1% in 2004 alone. According to
US Treasury figures, its balance of payments
surplus soared 76% from 2003 to 2004, and
its current account surplus increased to US$68.7 billion.
In the second half of 2004 alone, China's foreign
exchange reserves grew to $610 billion. In
the first quarter of 2005, China's real gross
domestic product (GDP) increased at a 9.5% annualized
rate, a torrid growth fueled by exports and
massive capital inflows. In addition, the US
dollar has depreciated in world markets in recent
years, taking the yuan with it. This has caused
both American and Chinese goods to be more
competitive in world markets. Speculative capital
continues to flow into China; commodity and energy
shortages can be found all over the country; and
speculative purchases of real estate and even
artwork have become common in Chinese cities. All
of this seems to indicate that the Chinese economy
is overheating.
At the same time, the
United States has contributed to China's growth.
Simply put, American consumers buy a lot of
Chinese goods. The US Treasury estimates that
China's surplus on trade in goods with the US
increased by $23.3 billion in 2004. In the first
four months of 2005, America's trade deficit with
China was measured at $21 billion.
In
short, within the past decade, China has become a
global economic power, and its actions are
starting to affect the world. Many economists
believe that once a country's economic development
reaches a certain stage, it is time to throw away
the training wheels and join free-market economies
that allow their currencies to float. According to
Senator Schumer, that time has already arrived.
"If China doesn't float, it throws the whole
international trade system out of whack."
China at least acknowledges this concern.
In March, Prime Minister Wen said his country
would eventually "create a market-based, managed
and floating exchange rate," according the
Treasury Department's report. So far, however,
Beijing has not taken much action.
Treasury Secretary Snow believes that
China must move quickly. The present currency
regime, he said, "poses risks to the health of the
Chinese economy, such as sowing the seeds for
excess liquidity creation, asset price inflation,
large speculative capital flows, and
overinvestment. It also poses risks to its
neighbors, since their ability to follow more
independent and anti-inflationary monetary
policies is constrained by competitiveness
considerations relative to China."
Thus,
because its currency is undervalued, Chinese goods
become artificially inexpensive in world markets.
All of which brings us to the trade issue.
The back story: Trade
This part of the tale begins in 2001, when
China joined the WTO, a global league of
free-trading economies. According to the terms of
the accession agreement, other WTO members were
permitted to "safeguard" their textile industries
by imposing emergency quotas that limit growth in
Chinese textile imports to 7.5% annually. This
agreement will last until 2008, when quotas on
Chinese goods will become prohibited under WTO
trade rules.
Compounding this situation,
the Multi-Fiber Agreement, a decades-old quota
program on textiles, was set to end on January 1,
2005. WTO members had been given several years to
phase out their quotas, but most waited until the
end in order to protect their domestic
manufacturing industries, according to Laura
Baughman, director of the Trade Partnership
Worldwide, an international trade consulting firm
based in Washington.
Naturally, when the
quota system expired in January, Chinese textiles
and clothing began to flood into Europe and the
United States. According to figures from the US
Office of Textiles and Apparel, Chinese imports of
cotton trousers surged by more than 1,500%.
Imports of shirts increased by 1,300% during the
first four months of 2005. Increases of similar
magnitude were found in many other textile
categories, and the EU has experienced the same
phenomenon. As a result, the US and EU have both
argued that they have little choice but to impose
the safeguard quotas allowed under WTO rules.
Experts ponder the
outlook Despite the charged rhetoric of
recent weeks, there is probably little likelihood
that China's economic relations with the world
will deteriorate into a trade war as such. For
one, the trade situation is not bilateral; the US
and EU have both taken issue with China's surging
textile exports. By agreeing to raise tariffs on
74 types of textile exports, China has already
shown that it is willing to cooperate with the
international community. Furthermore, as Baughman
notes, the safeguard restrictions are perfectly
legal under WTO rules. In 1995, all WTO members
began a 10-year phase-out period of the textile
quotas in place under the Multi-Fiber Agreement.
When China joined the organization in 2001, it too
agreed to drop the quotas by 2005. The imposition
of the safeguard measures is not necessarily a
case of China being victimized by the US and the
EU; however, there is no doubt that those
economies are taking maximum advantage of the
opportunity afforded to them by WTO rules in order
to preserve their textile manufacturing
industries, even at the expense of their own
consumers and retailers.
Having said that,
the tariff bill proposed by senators Schumer and
Graham is a different story, says Baughman. Under
global trade rules, one WTO member cannot
unilaterally raise tariffs against another member
without subjecting all members to the same tariff.
Such action on the part of the US Congress would
undoubtedly provoke China into filing a case
against the US with the WTO, which raises the
question: if such an action would be illegal, then
why threaten China with it at all? "This is for
the folks back home," says Baughman, noting that
the threat is simply a move by politicians to show
their constituents that they are protecting
domestic jobs.
However, the safeguard
quotas could have several negative effects. On the
American and European sides, producers will have
an incentive to charge customers more for
textiles, since the supply will diminish. In
addition, Baughman points out, importers will
simply shift their sourcing to other low cost
manufacturing country, such as Bangladesh or
India. On the Chinese side, an increase in export
tariffs would hurt textile producers, while at the
same time actually raising revenue for the Chinese
government (a tariff is simply a tax on goods,
after all).
The currency issue, on the
other hand, has been brewing for much longer than
the trade problem, and its effects are not just
speculative, they are already somewhat visible:
China's goods are artificially cheap, and its
Asian trading partners are not free to let their
currency appreciate freely because they fear they
will be undercut by cheap Chinese goods. China,
for the most part, has benefited as its economy
booms - although Beijing has had increasing reason
to worry about the negative side effects of
excessive growth recently, and the country's
massive accumulation of dollar reserves is hardly
beneficial if its side effect is to further weaken
the dollar.
Morris Goldstein, a senior
fellow at the Institute for International
Economics in Washington, says China should allow
the yuan to appreciate relatively soon because
there are two primary risks to not taking action.
First is the risk of instability if people expect
exchange rates to do nothing as capital continues
to flow into the country and it runs a current
account surplus. Second, he says, "people will
regard the Chinese as not playing by the rules".
China effectively has three options.
First, it can continue with the status quo.
However, this would still disrupt the monetary
policies of its neighbors and could cause China to
face retaliatory action by the US. This could also
cause unstable capital inflows on the part of
currency speculators, who hope to make quick buck
when the yuan finally does appreciate.
Second, China can let the yuan float
freely now. Doing so runs the risk of overvaluing
the currency and drastically cutting exports,
which many regions of China have become
economically dependent upon. It would also likely
cause significant instability in the country's
financial system, which could have a profound
effect on the global financial markets, including
US markets. A sudden appreciation of the yuan
would effectively cause its dollar reserves to
depreciate, which could in turn cause US interest
rates to rise. This could bring an end to the
current housing boom in the United States, and it
would undoubtedly affect the debt levels of US
credit card holders, which are currently sky-high.
The third option is to let the yuan adjust
gradually. Goldstein and his colleague Nicholas
Lardy have suggested a two-step process. The first
part would involve an initial revaluation of the
yuan by 15-25%. The second would be a "managed
float". that is, a re-pegging of the yuan to a
basket of currencies (such as the dollar, the yen
and the euro) with a relatively wide fluctuation
band. Goldstein also says that "the more
multilateral pressure that goes on China, the
better", noting that the Europeans, Asians and
notably the International Monetary Fund should
help China effectively manage its revaluation.
The IMF declined to comment for this
article, pointing reporters to its website, which
states: "Our position has been quite clear. We
have for some time believed that it is in the
interest of China to adopt a more flexible
exchange rate system, and the reasons are well
known. More flexibility would allow for an
autonomous monetary policy and cushion against
shocks. Such a move toward flexibility is best
taken from a position of strength, and the current
conditions would be favorable for such a step. We
keep in close contact with the authorities,
providing them advice as they request [it]. We
have a very active technical assistance effort
with the Chinese and continue to be impressed by
the growth in [China's] economy."
So where
does this leave us? In relative stability, one can
only hope. China has become far too integrated in
the world economy for it to be shut out - or for
it to shut anyone else out, for that matter. The
country's trade relations with the US and the EU
have effectively reached a tipping point, and in
all likelihood, safeguard quotas will be imposed.
However, they must be renewed each year, and the
possibility remains that this will not happen if
China makes good on its efforts to control its
textile exports. At any rate, the Asian giant only
needs to hold out until 2008, at which point the
quotas will be gone for good.
Because of
the trade issue, now seems as good a time as any
to address China's monetary concerns, and the US
rhetoric - including the Schumer-Graham bill - is
quite possibly an effort on the part of the United
States to nudge China to allow the yuan to
appreciate now rather than later. Nonetheless, any
effort to revalue will require the support of the
international community. China is the greatest
economic success story of the past decade. In a
mere 10 years, it has grown from a truly
developing economy to one that is able to have a
significant effect on the world's largest trading
blocs.
Speaking in Beijing in September of
2004, John Williamson, a senior fellow at the
Institute for International Economics, perhaps
summarized China's situation most succinctly. When
describing the possible revaluation of the yuan,
he noted that China has not yet experienced a
growth crisis. "This does not mean that China's
current policies deserve to be perpetuated," he
said, "but it does imply that any change needs to
be evaluated carefully to make sure that it will
not risk undermining China's success."
Brian Wingfield is a
freelance reporter based in Washington, DC.
(Copyright 2005 Asia Times Online Ltd. All
rights reserved. Please contact us for information
on sales, syndication and republishing.)
China "does not play
by the rules". The country's currency, which is
pegged to the US dollar, is undervalued, he said,
and Beijing should revalue it immediately. The
Chinese government, for the moment, has refused to
do so, prompting the senator to flatly state:
"China wants the advantages of free trade and not
the responsibilities." 
