It seems that the discussion between the US and China to work in tandem to support the world's economic recovery is starting to reach its boiling point. Remember that, last November, both countries went into talks to resolve the current imbalance between the West's extreme spending and the East's saving ways.
Now, the US is getting fed up on how China continues to keep its own currency, the Yuan, artificially low to give them an unfair advantage in trade. China has a pretty devious strategy to ensure that the value of the Yuan stays low relative to the US dollar. They have been stocking up piles and piles of greenbacks for almost a decade now! In fact, its total dollar reserves amount to $2.4 trillion to date.
Earlier this week, US President Barack Obama asked China to take on a more market-oriented policy with regards to its currency. In other words, the US wants China to “un-peg” its currency to the dollar.
How did China react to these accusations?
People’s Bank of China (PBOC) Vice Governor responded by saying that the PBOC was not keeping the value of the Yuan low in order to boost demand for Chinese exports. He even snapped back at the US, basically telling them to mind their own business and also saying that the US’s domestic problems are not for other countries to solve!
Naturally, this didn’t sit too well with the US politicians. Recently, lawmakers at the US Congress turned to Obama to call out China as a ‘currency manipulator’ at next month’s Treasury talks. In addition, lawmakers are reportedly proposing a bill that would give the US government more control in their efforts towards more balanced exchange rates. This could give the US government the power to impose stricter trade restrictions and tariffs on Chinese goods, which would effectively lessen demand.
Even though they risk the possibility of losing a big chunk of their exports from the US, China simply won’t back down. This shouldn’t be a surprise... In fact, it should be expected. China’s economy has been growing exponentially in the last decade, putting it on pace to pass Japan as the world’s second largest economy. In order to cement its place as a world power, China can’t show any signs of weakness, even if it means angering the mighty US.
Chinese officials argue that the US’ theory of currency rebalancing would have a major impact on the Chinese economy, and possibly even cause their economy to go through a double dip recession. Given the country’s place in the world economy, this could cause problems in other markets that rely on Chinese demand.
On the other side of the globe, the US together with its European allies were reasoning that China’s policy to purposely weaken the Yuan is causing China to monopolize the global export industry. You see, a weak Yuan makes Chinese exports relatively cheaper and more competitive. So if the US and China don’t find a middle ground, the global economy’s recovery could take a lot longer.
With China not budging despite threats from the US, the bickering between the two superpowers could get messier. The US was actually warning China that it could impose higher tariffs for China’s exports to the US. China, on the other side, could likewise hit the US back by selling some of its US treasury reserves if the US does so.
If the tension between the two continues to escalate, we could see this trade war have serious ramifications on the global economy.
Although it’s a remote possibility, let’s consider what could happen if China gives in to the pressure and removes the Yuan’s peg from the US dollar. This could result to a sudden drop in the US dollar’s value as China unloads its $2.4 trillion worth of reserves on the markets. Imagine how much of a ruckus this would cause in global trade and not to mention the currency market!
On a brighter note, global trade rebalancing could be underway once China decides to let the Yuan appreciate freely. Well, this is what the US is hoping for, right? Exports from the West, especially from the US, would then be relatively cheaper and could enjoy higher demand. China’s products, on the other hand, could suffer decreased demand. Western nations might reduce their dependence on China’s exports and focus on stimulating domestic demand for its own products.
In reality, global rebalancing won’t be that simple. China’s revaluation of the Yuan is probably just the first step in reducing the trade imbalance.