Experts say a sudden currency revaluation could shock markets. Photo Credit: Flickr

The valuation of China's currency has animated economists for over a decade. After years of pressure from Washington, China floated its currency in 2005, abandoning a strict peg to the US dollar and opting, rather, for an exchange rate pegged to a basket of international currencies. This move created a modicum of wiggle room for the Yuan, but US officials still say China grossly misvalues its currency and that this disparity significantly distorts global trade, exacerbating US and European trade deficits. Indeed, in an interview with CFR.org, US Treasury Secretary Henry M. Paulson says the Yuan "doesn't reflect reality" and the need for reform is even greater now than it was in 2005.¹

Legislators in Washington, meanwhile, demand a stricter approach toward China. On June 13, a bipartisan group of US senators proposed legislation that would require the Treasury Department to work with the US Federal Reserve and other banks to actively intervene (FT) in currency markets when they appear distorted.² The same day, the Treasury released its semiannual report on currencies, focusing heavily on China.³ The report says China's currency is "severely unbalanced" and calls for prompt action by the Chinese government, but stopped short of accusing China of currency "manipulation," a term that implies intent to gain an edge in trade.

Whether or not China is actively "manipulating," the balance sheet shows profound and growing trade disparities with the United States and other industrialized nations.

Whether or not China is actively "manipulating," the balance sheet shows profound and growing trade disparities with the United States and other industrialized nations. Skewed currency valuations only exacerbate the problem. The trade gap between European Union and China was the focal point of June 12 meetings between EU Trade Commissioner Peter Mandelson and Chinese Commerce Minister Bo Xilai. China's trade surplus stands at $22.5 billion, up 73 percent (AP) from a year ago.⁴ This 2006 Backgrounder looks at the burgeoning US trade deficit and efforts both to control US spending and to increase consumer culture in countries like China that carry substantial trade surpluses.⁵

Still, experts say a move toward equilibrium will take time. Paulson argues that, in the near term, the prudent course for the United States is to push China for greater "flexibility" with the hope that in the "intermediate term" the Yuan could be traded on the open market. The overwhelming fear among economists is that any rapid change could jolt markets. These concerns in mind, Morgan Stanley Chief Economist Stephen S. Roach argues in a recent online debate that pressing for quick changes in China's currency is the "wrong medicine at the wrong point in time."⁶ Roach also encourages the United States to look more pointedly at US economic failings: "There's a limit to what can be expected from China and a lot more we can ask of ourselves."

Footnotes:

¹ Paulson, Henry M. The Capital Interview: Paulson Says China's Currency ‘Doesn't Reflect Reality'. Council on Foreign Relations.

² Callan, Eoin and Krishna Guha. China Under Pressure Over Currency. Financial Times.

³ US Treasury. Semiannual Report on International Economic and Exchange Rate Policies.

⁴ EU trade chief says Chinese minister sees need to act over trade surplus. Associated Press.

⁵ Teslik, Lee Hudson. Two Deficits, Fed Turnover. Council on Foreign Relations.

⁶ Is China Growing at the United States' Expense? Council on Foreign Relations.




Contributed by Lee Hudson Teslik, Assistant Editor of the Council on Foreign Relations. Reprinted with permission from the Council on Foreign Relations.

To read another Global Envision article about the value of the Yuan, see China in a Vice Grip.



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