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Amid all the talk about the weaker dollar, there's one currency against which the U.S. would desperately like the greenback to start falling: the Chinese yuan. That's likely to begin soon, but the shift will be so moderate as to have only a marginal effect on the gaping U.S. trade deficit with China. It also will do little to lessen bilateral trade tensions over counterfeiting and other issues.
Chances are good that China will allow some appreciation of the yuan in the second half of 2005, but more for domestic reasons than because of pressure from the U.S. and other trading partners. China wants to reduce the risk of inflation posed by an undervalued currency as well as a further expansion of risky bank lending fueled by enormous capital inflows at the current fixed exchange rate of about 8.3 yuan to the dollar.
Beijing is inclined to make any changes in foreign exchange policy gradually. The Chinese probably will allow the yuan to rise less than 10% against the dollar, far below the 20% to 50% that many Western economists say is warranted by market conditions. For U.S. companies that compete with Chinese firms, the small yuan-dollar move will be overshadowed by China's huge advantage in labor costs, which are roughly 3% those of the U.S.
Even after Beijing relaxes the yuan's peg, expect the U.S. Chamber of Commerce, American manufacturers and others to urge the Bush administration and Congress to press China for more-flexible exchange rates. These groups also will continue pushing for action against the widespread counterfeiting of foreign goods in China and the country's foot-dragging on opening domestic markets. The U.S. also won't hesitate to take its case to the World Trade Organization (WTO) if China doesn't budge.
The U.S. shares an interest with the European Union and Japan in both market access and protection of intellectual property rights and could win concessions from China by presenting a united front. Similar cooperation between the U.S., Europe, Japan, Mexico and Taiwan led China to drop a tax rebate for domestically manufactured semiconductors last July. The U.S. and its partners had filed suit against China, arguing that the rebate constituted an illegal subsidy, but China agreed to a settlement before the WTO could render a verdict.
Meanwhile, other Asian currencies are finally showing renewed strength against the dollar. Since the end of July, the South Korean won has appreciated by 11% to its highest level against the greenback since before the Asian currency meltdown in 1997. The Japanese yen, the Taiwan and Singapore dollars, the Thai baht and the Indian rupee also are higher.
In part, the moves anticipate a Chinese shift on the yuan. But the Bank of Japan's decision to allow the yen to appreciate—rather than buying dollars to keep the yen weak and its exports more competitive—has played an important role as well.
"The currencies of the region effectively peg themselves against Japan, because Japan's is the [area's] free-trading currency," says David Durrant, chief currency strategist with Julius Baer Investment Management. "China's isn't, and these countries are competing with Japan to get into China." Japan is willing to risk letting the yen appreciate, so its competitors are increasingly willing to let their own currencies do likewise.
The appreciation of currencies across the region may ultimately help reduce the U.S. trade deficit with East Asia as a whole, though probably not by much. And any adjustment in prices probably won't be visible until 2006, as it will take until then for existing trade contracts to run their course.
China alone accounts for more than half the U.S. trade deficit with the Pacific Rim. Much of China's weight in America's Asian trade deficit stems from neighboring countries' outsourcing production to China, which offsets the volume of goods the U.S. previously imported directly from those countries.
The dollar's trade-weighted value has fallen roughly 15% over the past three years when measured against a basket of currencies of 37 leading U.S. trading partners. That basket includes major East Asian trading partners that have traditionally restricted or fixed their currencies' weights against the dollar—notably China, Hong Kong, Malaysia, Singapore, South Korea, Taiwan and Thailand.
By comparison, the dollar has fallen 26% over the same period against a basket comprising the major freely traded international currencies: the euro, the yen, the British pound, the Canadian and Australian dollars, the Swiss franc and the Swedish krona. Two-way trade with the countries using those currencies accounted for 36% of the U.S. global trade deficit in 2004, compared with 24% by China alone.
Researcher-Reporter: Michael J. Smith
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