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The New World War

It seems like another kind of world war, being fought in the realm of economics and international trade and currencies.  The US is of the opinion that China is subsidizing its exports by keeping the Yuan artificially undervalued, thereby killing US industry and trade. Evidence does suggest this eventuality in the form of a huge build up of Chinese foreign exchange reserves, where China buys huge quantum of dollars from the market such that its own currency stays undervalued. A lower Chinese currency implies that its goods are cheaper in foreign currency terms and other nations face a disadvantage as their goods are unable to compete with the prices of Chinese goods. Due to this advantage China also over produces and then indulges in dumping of goods in various parts of the world at low prices in foreign currency terms, thus damaging industries of other nations. Evidence also points to the fact that China is most involved in dumping as it has the most number of anti-dumping cases pending against it. Anti-dumping duties traditionally have been imposed against products like fabrics, auto parts, industrial chemicals etc. However, in the case of China, anti-dumping duties have been imposed on consumer oriented products like color picture tubes, radial tyres and some stainless steel products.

There is now a legislative move in the US to term China as a currency manipulator and a debate if some kind of import duty should be imposed on Chinese products so as to counter the effect of the artificially depressed rate of the Chinese Yuan. As a part of legislative developments, 130 congressional members have written a joint, bipartisan letter in this respect and the Obama government is legally required to determine if China and other nations are guilty of currency manipulation. Noted economist and Nobel Laureate, Paul Krugman has termed China’s currency management techniques as a most distortionary exchange rate policy any major nation has ever followed. Krugman further argues that China’s policy has made industry in other parts of the world uncompetitive and the interest rate lever to stimulate the suffering industry has become redundant as interest rates are near zero. Effectively Krugman is blaming China’s currency value for the West’s inability to move out of recession quickly as the interest rate stimulant in the West is at its best possible level. Krugman has proposed a surcharge of 25% on all Chinese products.

However, the Chinese have vehemently denied any role in currency manipulation and blamed the US for its economic woes. The Chinese have suggested that the US needs to look at revamping its own economic model and should not blame Chinese policy for its high unemployment rate. Think tanks in the US also believe that the high US trade deficit is the result of high consumption rate in the US accompanied by a low savings rate. However, one can argue that the high consumption rate in the US has been abetted by relatively cheaper Chinese goods and services and one cannot look at the issue in isolation.

Is there a solution? If the Chinese were to allow their currency to appreciate by 25% to 30%, the rate adjustment could help change the balance somewhat, but is unlikely to be the solution for making any major reduction in the US trade deficit. However, such an appreciation in the Chinese currency could have drastic ramifications for the world economy as was the case when Japan underwent an economic shock in the 1990s on the back of an appreciation in the Yen. The shock slowed down Japan’s growth rates and its low interest policy has also not helped it regain the earlier rates of growth.

In essence, while the Chinese currency may be artificially undervalued, there seems to be no immediate solution in terms of a revaluation of its currency as it could dampen industrial activity in China and add to the global recession. A gradual revaluation of the Chinese currency could hold the solution to a rebalancing of the world order.