SO, the United States has once again intensified its political pressure on China to hasten the appreciation of the latter’s currency, the yuan, as a new legislation to allow tariffs to be imposed on imported goods from “countries with undervalued currencies” was passed by the US House of Representatives over the week.
It is obvious that the bill was mainly targetted at imported goods from China, whom the United States have long accused of currency manipulation to gain an unfair trade advantage and contribute to global imbalances.
While the bill has yet to be enforced as a law (it is unlikely to be passed as one, according to experts), the latest development gives us reason to be concerned of a looming trade war.
The US Treasury Secretary Timothy F. Geithner may think that the rising tension over the yuan, or sometimes referred to as the renminbi, would not lead to escalating trade sanctions, but to believe that China would just sit around and not react to any trade sanction imposed on its goods is being naive.
Last Sunday, China had already moved in to impose steep tariffs of up to 105.4% on poultry imports from the United States. Although the Chinese response towards the new legislation has so far been reported to be muted, any further threat to the country’s trade competitiveness would likely result in a tit-for-tat reaction later.
And if the continuous pressure on the Chinese yuan erupts into a full-blown trade war between the two world’s largest economies, it could be destabilising for the global economy through spill-over effects.
Gradual yuan appreciation
Meanwhile, some economic thinkers assert that the rising pressure on the Chinese yuan is totally unjustified.
Georges Ugeux, the former executive vice-president of the New York Stock Exchange, for one, thinks that “the pressure on China to quickly appreciate its yuan further is more political than economic”.
“China should not bow to such pressure, but should instead allow its currency to move up in a stabilised manner, as we see it happening now,” Ugeux says to the applause of participants at the “Dawn of the New Decade: Alternative Investments in Asia” conference that was held in Kuala Lumpur recently.
Since the Chinese government removed the two-year peg of the country’s currency to the US dollar in June this year, the yuan has already appreciated more than 2%, reaching its strongest level in 17 years at 6.684 to the US dollar yesterday. Compared to a month ago, the yuan has gained 1.86% against the greenback.
Large gains in China’s currency will not be in anyone’s interest, says Dr Fan Gang, who was also in Kuala Lumpur recently as a panel speaker of the conference.
“A big fluctuation is destabilising not only to the Chinese companies, but also to the global financial system,” explains the prominent economist, who is also the director of the National Economic Research Institute in Beijing and chairman of the China Reform Foundation.
“The yuan is already in the process of appreciating against the US dollar, and we can be sure that it will continue to rise further,” Fan adds.
He also points out that the global imbalances will naturally be addressed as the US dollar continues to weaken against other currencies, as then, the US products will become cheaper to other countries, and that, in turn, will boost the country’s exports.
For the next two months, currencies are expected to remain a hot topic as global leaders congregate at the International Monetary Fund (IMF) and Group of 20 meetings to discuss their concerns over the rising trend of governments keeping their currencies weak to gain competitive advantage in trade.
Such a trend has actually prompted Brazilian finance minister Guido Mantega to warn of the rising threat of a currency war. While IMF managing director Dominique Strauss-Kahn does not see the risk of a currency war, he does acknowledge that governments’ intervention to prevent their currencies from appreciating as a disturbing trend.
So far, among the Asian countries that have intervened over the last few months to keep their currencies from appreciating further against the US dollar are Japan, South Korea, Thailand and Vietnam. These governments’ efforts are to mitigate the negative impact of their strengthening currencies on exports, and hence, their economies.
By and large, Asia is still an export-dependent region, with their produce mainly destined for developed markets such as the United States and Europe. But the region’s currencies have been strengthening against those of the developed countries, hence the concern over its negative impact on their exports.
“While the emergence of China’s demand will provide some support to intra-regional trade, the country can only provide a partial offset to weaker demand from advanced economies,” Affin Investment Bank Bhd’s chief economist Alan Tan opines.
“Most Asian countries are still dependent on exports, particularly to the United States,” he adds.
The strengthening of Asian countries since the start of the year is driven mainly by sound economic fundamentals of the respective economies.
“Compared with the United States and European region, which are facing numerous structural problems such as macro imbalances and weak growth, Asian economies are experiencing quite the opposite circumstances; hence Asian currencies have broadly outperformed the advanced economies for most of this year,” RAM Holdings Bhd senior economist Kristina Fong explains.
Economists point out that the widening interest rate differentials between Asian countries and developed nations are also working in the favour of Asian currencies, as foreign funds are drawn to invest in this fast-developing region for higher returns.
Fong says she expects the favourable interest rate differential to remain for at least another year or so, as Asian countries continue to tighten their monetary policy, while developed nations continue to keep their interest rates super low at less than 1% to boost their sluggish economies.
Among the Asian currencies, the Malaysian ringgit has been one of the best performing so far this year, having appreciated almost 10% since the beginning of the year to quote at 3.0853 per US dollar yesterday. Ringgit has been testing new 13-year highs over the last few weeks.
Economists attribute the outperformance of Ringgit against regional currencies mainly to catch-up factor as it has generally lagged for most of last year.
Nevertheless, they believe further upside of the ringgit against the US dollar will likely be capped, as the central bank will most likely intervene to slow the currency’s appreciation in the near term to prevent the loss of export competitiveness.
“We believe Bank Negara is monitoring the situation closely – keeping tabs on relative competitiveness and whether the prevailing exchange rates have adverse implications on the real economy or encourage speculative financial flows, which could undermine currency stability. The cause for intervention will be greater when there is disruptive currency volatility,” Fong explains.
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