The Great Currency Debate
On Thursday, the U.S. House of Representatives passed the Currency Reform for Fair Trade Act, which aims to crack down on Chinese currency manipulation by targeting imports from China and other countries with currencies that are perceived to be undervalued. With a final tally of 348 to 79, the bill was bi-partisan and passed with ease.
The fact that more than 100 Republicans voted in favor of the bill suggests that no Congressman wants to be on the wrong side of the China issue in advance of the November elections. Imports from China are generally blamed for the loss of American jobs overseas and stubborn high employment in the United States. With jobs now the number one issue on the minds of voters, any measure that promises to reverse job outflow, whatever its merits, is viewed as good politics.
Congressional leaders were quick to try and make political hay out of passage of the bill.
“For so many years, we have watched the China-U.S. trade deficit grow and grow and grow,” Speaker Nancy Pelosi said. “Today, we are finally doing something about it by recognizing that China’s manipulation of the currency represents a subsidy for Chinese exports coming to the United States and elsewhere.”
“I believe in free markets and open competition. I believe that American companies and workers can win under those conditions. But the rules have to be fair—and for years now, it has been clear that China’s currency policy unfairly tilts the field in its direction,” Majority Leader Steny Hoyer said in statement. “By deliberately keeping the value of its Yuan low, China is able to sell products here at an artificially low price. As a result, domestic manufacturers — whose prices would be much more competitive if China allowed the market to set the value of its currency — go out of business. And American workers lose their jobs.”
In the great currency debate which is now raging and which threatens to grow wider, June 19 is a key date. That is the day that China, by far the world’s largest currency trader, announced that it would no longer peg the yuan to the U.S. dollar, but would instead peg it to a basket of currencies. What China’s announcement meant in practice is that at the margin, beginning on June 19, China would tilt its purchases in favor of buying assets denominated in the euro, the Japanese yen, the British pound or some other major currency, rather than those denominated in the U.S. dollar. When an investor with $2.5 trillion of buying power makes such a statement, markets tend to listen.
Here is what has happened since.
As of the September month-end, the euro has increased in value by 10.3% against the U.S. dollar since June 19, the pound by 6.3%, and the yen by 7.8%. In fact China’s purchases of yen-denominated securities has heightened trade tensions between Japan and China to the point where the Japanese have complained publicly that China is effectively pricing Japanese products out of the market with its yen purchases, threatening to derail Japan’s economic recovery.
In the broadest measure possible, the United States Dollar Index (“USDX”) has declined by over 9.6% percent since June 19. The USDX measures the value of the US dollar against a basket of currencies that includes the euro, yen, pound, Canadian dollar, Swiss franc and the Swedish krona — exactly the currencies that China is most likely including in its own basket and which are now appreciating as a result. The USDX began in March 1973 with a value of 100.000 and has since traded as high as the mid-160s. At its current level of 78.691, the USDX is approaching its 33-year low of 70.698, which was reached on March 16, 2008.
While it is true that China’s yuan has appreciated by less than 2 percent against the dollar since June 19, and the slow pace of yuan appreciation is what has drawn the ire of U.S. policymakers, the fact is that the exchange rate between the yuan and the dollar is only part of the overall currency picture. China is a $5 trillion economy, but the gross domestic product of the European Union is $16.4 trillion, that of Japan is $5 trillion, and that of the United Kingdom is $2 trillion. Against the currencies of all of these countries, the value of the U.S .dollar is anywhere between 2 and 10 percent lower today than it was on June 19. Meanwhile, the dollar continues to weaken as speculation of quantitative easing by the Federal Reserve mounts.
If anything, the U.K., Japan and the ECU countries are being hurt more by U.S. currency policy than they are by China’s. As the economies of these countries struggle to recover, expect the currency debate to widen beyond China’s currency policy, to include the weak dollar policy being pursued by the United States.
As the Beggar the World editorial which appeared in today’s Wall Street Journal so aptly put it:
China’s ambassador to the World Trade Organization, Sun Zhenyu, was speaking for much of the world this week when he said that “We are very much concerned about how the U.S. would take practical and responsible measures to prevent the dollar glut and maintain the stability of the currency.”