Increase In Yuan Could Lead To Significant Inflation

The concerns of foreign trade partners have been somewhat relieved now that Beijing has allowed the yuan to appreciate, but some US policymakers are not yet satisfied. Some …

The concerns of foreign trade partners have been somewhat relieved now that Beijing has allowed the yuan to appreciate, but some US policymakers are not yet satisfied. Some analysts also believe the low yuan has helped to keep interest rates under control, and believe a higher yuan could cause inflation to rise significantly. See the following article from Money Morning for more on this.

By allowing the yuan to appreciate, China at least temporarily placated foreign trade partners that had expressed concern about the currency’s value. However, the decision has done little to quell criticism from many U.S. policymakers and trade groups who are angry that the Obama administration refuses to brand China a “currency manipulator.”

Still, while the yuan does need to appreciate, critics in the United States should remember that the dollar too is flawed, and that the uneven relationship between the two currencies has often worked to America’s advantage.

Treasury Secretary Timothy Geithner has thrice declined to tag China as a currency manipulator in his biannual report to Congress. Geithner even delayed the release of the most recent report to give China more time to adjust its policy. That move paid off in June when just days ahead of the Group of 20 (G20) leaders’ summit in Toronto, Beijing announced that it would allow the yuan to appreciate against the dollar. Since then, the currency has risen about 1% against the greenback.

Geithner, who made two visits to China in the spring for closed-door talks with top officials on the issue, called the policy shift a “significant step” in his report, but said the yuan remains “undervalued.”

What matters now is “how far and how fast the renminbi [or yuan] appreciates,” Geithner said, adding that the United States “will closely and regularly monitor the appreciation” of the currency.

China had allowed its currency to appreciate by 21% from July 2005 until July 2008, when it pegged the yuan to a value of 6.83 per dollar in an effort to boost exports during the deepest contraction in trade since World War II.

With the U.S. unemployment rate soaring many U.S. policymakers and trade organizations implored both President Obama and his treasury secretary to take a harder line with China. And Geithner’s report, which again passed on the opportunity to chastise Beijing, drew their ire.

“Everyone knows China manipulates its currency,” said U.S. Sen. Chuck Grassley, R-IA. “If the President continues to avoid acknowledging China’s currency manipulation and fails to address it in a meaningful way, Congress will have to act.”

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Some Democrats agreed.

“For years, American workers have not been able to compete on a level playing field because of China’s undervalued currency and now they are struggling to secure jobs in the midst of a painful economic crisis,” said U.S. Sen. Christopher Dodd, D-CT.

However, Money Morning Contributing Editor Keith Fitz-Gerald and many other analysts believe policymakers should give Beijing, and the Obama administration, a slightly longer leash concerning the yuan – and for good reason.

“It would be really stupid and foolish for the U.S. to label China a manipulator,” Fitz-Gerald said in an interview. “There are plenty of countries around the world that peg their currencies to the dollar so labeling China in effect is a blatant attempt to discriminate against that country.”

“If the notion is that we don’t like the fact that they have a manufacturing advantage, then call it what it is rather than simply hide behind the label in an attempt to hide the issue. Or, label everybody a manipulator to ensure an even playing field,” he added. “As for the notion that China’s currency is undervalued, so what if it is. There’s another side the coin here in that what this points out is that the dollar is significantly over priced.”

The dollar has risen some 21% against the euro in the past two years and about 13% against the European currency in the past six months, as the sovereign debt crisis panicked investors.

The International Monetary Fund (IMF) said on Thursday that the US dollar was “somewhat overvalued from a medium-term perspective.”

What’s more is that Chinese ratings agency Dagong International Credit Rating Co. recently ranked the United States below China in terms of credit risk. The agency – which is seeking to balance the “monopoly” of Western ratings agencies Standard & Poor’s, Moody’s Corp. (NYSE: MCO) and Fitch Ratings Inc. – cited high debt and slow growth as reasons the United States is likely to face higher borrowing costs and risks of default.

Dagong rated U.S. government debt AA with a negative outlook, and China AA+ with a stable outlook. That contradicts the three big Western agencies, which have been criticized for giving high ratings to mortgage-linked investments that went bad when the U.S. housing market collapsed in 2007.

Moody’s gives China a local currency debt rating of A1 – four notches below the United States – and S&P gives it an A-plus.

“A significant difference between Dagong and the three international rating agencies, i.e. Moody’s, S&P and Fitch in terms of their rating results is that Dagong emphasizes more on the country’s capability to pay its debt,” the agency said in a statement.

Dagong rated Switzerland, Australia, Singapore, Canada, and the Netherlands as AAA. It also gave emerging markets such as India and Brazil higher marks than its Western counterparts.

Fitz-Gerald noted the irony of U.S. policymakers, who ran up huge amounts of debt as a means of coping with the financial crisis, now criticizing China’s currency policy.

“The same U.S. leaders who have been pushing to hang this manipulator label on China and impose sanctions are the same ones who tried to end the financial crisis by creating a river of debt that will haunt us for years,” said Fitz-Gerald. “The thing to remember is that the only reason we have not seen completely out of control interest rates in this country as a result of the $12.2 trillion our government guarantees is that we’ve been able to export our inflation to China courtesy of a lower yuan.”

According to Fitz-Gerald, the yuan’s low value comparative to the dollar has helped keep inflation low in the United States, even while it’s surged in China.

“When the Yuan starts appreciating, inflation is going to come zipping back onshore, particularly when it comes to clothing, toys, medicine and many other things,” he said. “So unless you’re prepared to see your Wal-Mart [Wal-Mart Stores Inc. (NYSE: WMT)] bill triple, you better hope China can keep the yuan as low for as long as it takes.”

Of course, none of this is likely to keep critics from clamoring about the yuan. China’s trade surplus rose to $20.02 billion in June, the highest level in six months. Its foreign exchange reserves, the world’s largest, reached $2.454 trillion.

“China has reported another strong trade surplus, and [Tuesday] we are going to see another large U.S. trade deficit,” Royal Bank of Canada economist Brian Jackson told The Wall Street Journal. “This contrast will likely add to the international pressure on Beijing to allow further currency gains to make a bigger contribution to global growth.”

Still, Fitz-Gerald warns not to take the yuan for granted, because it will continue to move steadily higher, and it will become an increasing threat to the U.S. dollar as it does so.

“The dollar remains a significantly flawed currency, while the yuan, flawed though it may be, is probably the strongest fundamental currency on the planet and, my guess, is likely to be the world’s next reserve,” he said.

This article has been republished from Money Morning. You can also view this article at
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