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Will China Dance the “Plaza Accord pas de deux”?

|Includes: AOMFF, BDRAF, BIDU, CHL, VAALCO Energy, Inc. (EGY), KWHIY

 “I have no doubt that a revaluation will happen over the next two years.  The timing, ironically, gets delayed by external pressure.”

                                             --Mohamed El-Erian, Barron’s (March 20, 2010)


The effects of Copenhagen are still being felt.  In December, during the global forum, a minor Chinese policy official publicly berated Barack Obama, hectoring him in a manner extremely strange for Chinese government emissaries who usually emphasize quiet decorum at such events.

China’s intransigence and its aggressive theatrics doomed the global climate forum and stunned European policy makers in particular. It showed the limits of the existing international framework despite their best aspirations.   More to the topic, it precipitated a new “realist” appraisal of China on the part of the American Left.  There was suddenly recognition that the emerging power might not simply need a dignified “place at the table” and then always be a progressive player on global agendas.     In fact, it might be more like the US –a hungry solipsistic nation, driven by unilateralist tendencies and obsessed with its own big domestic needs.  

The December detonation at Copenhagen struck deeply at the sunny multilateralism espoused by Democrats in the US.     A few weeks later, in a standard New Year’s forecasting article, progressive-in-chief Paul Krugman stated that he believed that 2010 would be the year we "call out" China.[1]

Two months later, the arm-chair forecaster became the agent provocateur, precipitating the fulfillment of his own prophesies.   In his March 15, 2010 column in The New York Times, Krugman recommended that the US impose a 25% tariff on Chinese imports unless the Chinese appreciate the renminbi.  The piece set off a cascade of official declarations from the highest level of the US and Chinese governments.

President Obama’s remarks three days later embraced the logic of the article and were measured and diplomatic.   Wen’s reply the following Sunday and the next-day resolution by 130 congressmen to look into the peg were far more inflammatory and suggest just how quickly the tinder of a long-un-countenanced issue can burst into crisis.  Just as the stock market rolled up a strangely sleepy but statistically aberrant eight day uptrend, there was suddenly talk of “trade war.”  

Several thoughts come to mind on this crisis:

First, it’s a shame that a currency revaluation has to be such a political “event” --charged with bi-lateral rhetoric, lagging a build-up of problems, and filled with recriminations.    It has been a noticeable failure of the present currency regime since its inception in the early 70s.  Though it beats the gold standard on growth, the floating exchange rate system lacks inherent balancing mechanisms.  Arvind Subramanian’s proposal that “a multilateral rules-based solution” be set up in the WTO to deal with such issues sounds like an excellent long-term fix, though it will have no effect on the present issue.   As the Peterson Institute fellow stated in FT recently:

What is needed is a new rule in the WTO proscribing undervalued exchange rates.  The irony is that export subsidies and import tariffs are individually disciplined in the WTO but their lethal combination in an “undervalued exchange rate” is not.[2]


Second, the US might be jawboning a revaluation more for the developed markets in general, not just for itself.   It might be more an example of the hegemon operating on behalf of the system itself.  

US manufacturing exports to China are limited. China’s list of “approved products” actively avoids US manufacturers.   But China’s peg is severely hurting US trade partners in Europe and Asia.   It is forcing the adjustment process not so much on the US itself but on to almost every other country. Even Brazil has had to impose short-term capital controls.

The quick and supporting remarks from both Japan and Europe on a revaluation would suggest that.  "Germany welcomes the move," German Finance Minister Hans Eichel said in a statement.  And at a press conference last Monday, Yoshihiko Noda, a senior vice finance Minister, stated:  “I basically think that making the Yuan flexible would be positive, not only for the world’s economy, but also for China’s.  Many of China’s neighbors seem to have questions about the dollar peg.”     Indeed, Korea, Taiwan, and Malaysia have all been trying to cap their currency advances to compete with Chinese trade more effectively, more or less confirming the “depressing effect” that Krugman suggested in his article. 

This vocal support by other players suggests that there have been active “back channel efforts” on the issue for months.   China’s Ministry of Commerce has allegedly been doing impact studies of a Yuan rise on textile manufacturers since early this year.[3]   Exporters like Germany and Italy in particular need market share to perpetuate their economies and insure tax revenues.  The US cannot risk having them fall into the kind of problems Greece now faces. 

The Yuan-dollar peg has been in place since July 2008 and helped China weather the credit crisis.  China has been a bastion of stability due to the peg, its stimulus, and its proactive good governance.   But the world is moving into a new phase of recovery and a new course is required.

Whereas most of the developed markets are dealing with anemic deflationary conditions, China never technically went into recession.   China’s economy is actually overheating in certain areas, like coastal real estate.  In February, its CPI rose 2.7% from a year earlier, and nearly double the 1.5% in January.   Its economic growth lurched to 10.7% last quarter, and property prices in 70 cities rose nearly 11% year over year.   The IMF forecasts 10% growth this year and 9.7 % this year.   The low Yuan and massive stimulus combination are now generating an inflation unwanted in China, but perhaps desired globally.


Third, a modest revaluation of the Yuan is not only desirable but inevitable.   There will be near-term negatives for both China and the US, but if a trade war can be averted, they are overblown in comparison to the long-term rebalancing.  

The following list might best characterize the China’s fears:

1.      A revaluation will hurt exporters already operating at razor thin margins, and according to Shaun Rein, Managing Director of the China Market Research Group, may lead to –at worse--another 5 million job losses.

2.      This might create social unrest.

3.      The Yuan is no longer as undervalued.  A rise in the minimum wage and the new enforcement of medical benefits for employees has already affected profitability at firms.

4.     The Chinese government will have a smaller treasury to generate needed modernization projects.

In comparison, here is the list of near-term negatives to the US:

1.     It will hurt the purchasing power of the US consumer, with higher prices in  stores.

2.     Higher interest rates nationally

3.     US corporate profits will be hurt, as most of manufacturing costs from China are a tiny fraction of the retail cost.  This will only hurt US companies more.

4.      A Chinese sell-off of US treasuries.  No one will buy our debt and interest rates will soar.

Long term positives for China include:

1.     Chinese consumers get more purchasing power –a well-deserved measure -- as the government and exporters have essentially kept them poorer than necessary.  Mao kept them poor for 30 years for the sake of a “worker-peasant” utopia, a state prerogative.  Now the CCP keeps them poor for the sake of a nationalist project and its own self-preservation.    The era of “export-platform Asia” is ending; the Chinese need to become active consumers.


Near term positives for the rest of the world include:

1.     Low-margin factories might now be sent to Vietnam, Cambodia, Uganda or other parts of Africa –countries that need those jobs and are at a lower stage of economic development than China.   These countries will also be more likely to buy US goods.


2.     Higher value-added manufactures from the US, Europe and Asia will be more competitive with China.  One example: China is developing a high speed rail industry that sets out to remove all components imported from Germany, France and Japan.  Three years ago, Chinese companies had no ability to make parts for their systems.  Now its state-funded industry threatens to displace companies such as Siemens (SI), Alstom (ALSM.Y), Bombardier, and Kawasaki (KWHI.Y) from any involvement in their domestic rails, and is competing on international projects with them.   A mercantilist country competing on this level should not be hiding behind a currency peg.


Long-term positives for the rest of the world include:

1.      The future of world growth now requires a greater consumption patterns within Asia.

2.     This is an appropriate re-balancing of the currency regime, similar to both the Plaza Accord and the Reverse Plaza Accord (which was initiated in 1996 to help the yen and strengthen the dollar).  Though it can be very disruptive and very post-factum in its response, it is necessary to rectify imbalances.   



Fourth, the US must defend the present currency regime.   It is a flawed system.   It is bubble-driven and lurching, and dangerous to small nations with low reserves.  But it is the only regime we have or will have for another twenty years.  It also is ultimately the most growth-oriented currency regime in history.   (The Euro’s recent weakness suggests that any future “Asian monetary unit” might have its share of problems)

The gold standard offered nice balancing mechanisms but it forced extreme restrictions on global growth.  Today’s “post-Bretton Woods” regime requires active negotiation between the major players but it is very expansionary in monetary terms.  Though often criticized, it is probably far more responsible for the vast Asian middle class and the global wealth that was created during the 1973-2008 period than anyone would want to admit. 

Indeed, to grow, most of Asia has followed an export-platform model of economic development directed specifically to the US market.  This was an important component to US geo-strategy during the Cold War period -- to stabilize those few island nations and peninsular enclaves along the Eurasian landmass that were not communist.  It was not designed for China, an adversary.

Since dropping the gold standard in 1971, the present currency regime has required a strange dance of re-calibration between the “major powers” from time to time.  If China wants to be a player in the international financial system, it will have to learn to dance this awkward dance.   In 1971, Nixon’s Treasury Secretary famously stated its “our currency, but your problem” and imposed a temporary 10% surcharge on imports.  The tax was removed a few months later after Germany, Japan, and others raised the dollar value of their currencies.   This may have been impolite, but the Warsaw Pact offered far worse indignities.

In 1985, the Plaza Accord forced Germany and Japan to again strengthen their currencies and the measure did help US manufacturing in the 1986 to 1995 period.   The Endaka created an asset bubble in Japan five year later, but other more structural factors were in play to cause the later Depression.

The Reverse Plaza Accord of 1995 suggests it’s not just a one-way street, but truly a range-bound negotiation. Though it hurt US manufacturing, Treasury Secretary Rubin thought that the Japanese economy needed a weaker Yen to ensure Japan’s economic strengthening.    The result of the stronger dollar was an asset bubble in the US that also burst five years later. 

China shouldn’t paint itself into a corner with nationalist rhetoric.  The US spent the 20th century laying the groundwork for a liberal international order that China initially rejected.   From 1949 to 1980, the People’s Republic of China attempted a self-contained economic utopia that –through the Great Leap Forward and the Cultural Revolution, ultimately degraded its population and caused more human suffering than any other period in its history.   Its efforts in the 60s to export its “worker-peasant” / collectivist approach to parts of Africa and Asia failed in those societies as well.  

Embracing a relationship with the US and its non-communist allies in Asia in the mid 70s has helped more Chinese arrive at more fulfilling, affluent lives than ever in its long history.    No one in China would trade the “open” years of 1980 – 2010 for the ”closed”  years of 1950 – 1980.  Yes, the US is a hegemon, but it offers a far more benign hegemony than most in history.  

So will China dance the “Plaza Accord pas de deux”?  The existing currency regime requires it.    In the prior Accords, the negotiation was with Germany, Japan, France—strategic allies facing at the time a common external threat.   America’s geo-political relationship with China has not been resolved.  So this time is very different.

Wen Jiabao says that he opposes measures “to force countries to appreciate their currencies.”   Is he stating then that China will not work within the existing exchange rate system?  After all, as we have seen, the present fluctuating rate regime requires periodic adjustments among its primary actors to rebalance the system and keep unemployment from flowing too much into one nation in particular.   

But, as it did with Copenhagen’s emission targets, China sees the revaluation as some Washington-sponsored assassination plot, a crafty Endaka to cripple their ascent. 

As you’ll remember, in late 2003, when Zheng Bijian first used the term “peaceful rise” at the Boao Forum for Asia, he was discussing that, in the past, a rise of a new power often resulted in war or a concerted subversion of the international order.  He believed that this was because these powers "chose the road of aggression and expansion, which will ultimately fail."[4]

So, does China’s “peaceful rise” doctrine suggest it will embrace the existing international regime?[5]   Or is it a temporary mask for a strategic competitor fully intent on disrupting that order?   Though Japan and the West decided against active containment years ago, seeing a weak China as more destabilizing than a strong one, there remains great trepidation in the developed world over the PRC’s future role internationally.   


[1]  Paul Krugman, “Chinese New Year,” New York Times, December 31, 2009

[2]  Arvind Subramanian: “The Weak Renminbi is not just America’s Problem,” Financial Times, March 18, 2010, p. 9

[5] In 1995 and early 1996 China attempted aggressive action against Taiwan in a missile crisis and against the Philippines by seizing Mischief Reef in the Spratly Islands.  Later In 1996 it saw a renewed Japanese-US defense treaty in partial response to those actions.  The hardliners in the CCP were sidelined.  It signed a “constructive strategic partnership with the US in 1997 and Hu Jintao’s “peaceful rise” agenda was later articulated in 2003, ushering in a great period of wealth and growing influence.


Disclosure: no positions

Disclosure: no positions

Disclosure: no positions