Home | Finance | Feb/Mar 11

Finance » Feb/Mar 11

Currency Concerns - Understanding complaints over China’s currency value

image

China’s foreign exchange policy

With the American economy mired in a sluggish, jobless recovery, politicians are turning in every direction to point blame and find a panacea for the problems facing the American economy. On the receiving end of many of these complaints lies China. This focus has predominantly been a result of the country’s foreign exchange policy and the perceived negative effects it has on the U.S. economy. China has been labeled, although not officially, a “currency manipulator” due to the actions of their government pegging the value of its currency, the Renminbi, to that of the U.S. dollar. Although the level of value of the Chinese currency is perceived as being set artificially low, there seems little the U.S. administration is willing to do to alter this situation.

The focus of the U.S. complaint over China’s currency value is not so much that it exists, but rather how it exists. In short, China is accused of maintaining an artificially low exchange rate through intervention in the currency markets. China, unlike most large manufacturing economies, does not utilize a floating exchange rate policy but rather pegs their currency’s value to that of the U.S. dollar.

The most oft-cited effect of this policy is the result it has on exporters. Simple economics dictates that consumers seek out the lowest cost goods, which are more frequently being provided by overseas producers. Furthermore, exchange rate policies do not only affect domestic consumption, they also affect domestic production. Persistently low currency rates provides an incentive to domestic firms to outsource their own production to regions where they can lower, sometimes dramatically, their large overhead of capital investment and employment wages. By transferring production overseas, firms can lower their costs and become more competitive with their domestic pricing.

Currency manipulators

As demonstrated by these two examples, this situation can create structural changes to an economy. Not only are individual consumers persuaded to purchase foreign goods by the allure of low prices, but companies are encouraged to export the production of their goods overseas. Both effects support an offshoring of production and work to hollow out the economy–a fact that is troubling to politicians. Unfortunately, fiscal and monetary policies such as stimulus spending and money supply expansion act solely as a short-term crutch and do not address the structural reforms that are required to facilitate a sustained “recovery” in the normal sense of the word.

Regrettably, there does not seem to be an easy solution to this situation. The U.S. administration seems very reluctant to directly engage China on currency reform discussions. Twice annually, the Treasury department submits a report to Congress where they disclose countries they see as “currency manipulators”. Up to this point, the Chinese have eluded such a label despite a chorus of dissent from both sides of the aisle. Although officially this is done to pursue diplomatic progress, there are widespread thoughts that this is the price the U.S. must pay for having China as its largest creditor.

Given that the exchange rate policy remains and the U.S. seems unwilling to press the issue, the status quo is sure to remain for the foreseeable future. The global imbalances produced will continue to exude their forces on the U.S. economy and if the current recovery underway proves fleeting or continues to be a “jobless” one, there is no doubt this will force Congress or the administration into some type of action. Stay tuned.

Sean Weaser is a Principal at Integra: Private Investment Management. Sean can be reached at sweaser@integra.com.