In April, when the US government postponed a report that could have labelled China a “currency manipulator”, the world heaved a sigh of relief. Perhaps this would give Chinese leaders the political space to unilaterally consider currency reform, instead of stoking bilateral tension. The ball was in China’s court.
By some accounts, China is ready to hit the ball. According to China’s central bank on Saturday, it appears set to “proceed further with reform of the RMB exchange rate regime and to enhance the RMB exchange rate flexibility”.
It’s still unclear what exactly China will do: What seems most likely is that the central bank will give up the dollar peg it has had in place since mid-2008, and move back to pegging the yuan to a basket of currencies, as it did between 2005 and 2008.
Given how adept Beijing policymakers have become at gaming the global system, we won’t rule out short-term tactics behind this announcement. The Group of 20 summit in Canada this week is bound to focus attention on the undervalued yuan; Beijing, which spent most of last week squirming under pressure, is now going to earn plaudits. What’s more, the euro crisis has hurt China’s competitiveness in that continent: As the euro falls against the dollar, the yuan pegged to the dollar has risen against the euro. A basket of currencies including the euro helps then.
But if China is sincere about long-term currency reform, then there is a strategic move at hand—a praiseworthy one, integral to global rebalancing. Earlier this month, as manufacturers in China announced wage hikes, Beijing gave strong indications that it would transition away from the low-wage export model that has powered its economy for the last 25 years. Savings, whose excess has so far skewed the economy, will thankfully fall.
None of this rebalancing will occur overnight, and we shouldn’t expect otherwise. The central bank has cautioned, as it did again on Sunday, that exchange-rate reform would be gradual, without one-off adjustments or large appreciations.
So global leaders should consider giving China some room for adjustment. In the meantime, we’d suggest they focus on the other side of the imbalance.
In fact, the ball is now back in the West’s court. But with an anaemic and possibly jobless recovery in the US, not to mention a full-blown European crisis, the Federal Reserve is in no mood to raise interest rates—until 2012, as a Fed researcher recently argued. Perhaps it’s China’s turn to label the US an “interest-rate manipulator”.
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