In a classic case of a stopped watch being right twice a day, a situation is developing where the Obama Doctrine of conciliation is actually the wise course. Last week, Treasury Secretary Timothy Geithner bucked Democrat-friendly lobbyists and his Party’s Congressional delegation in deferring on an April 15th [Congressional] deadline to rule on PRC’s status as a currency manipulator. Treasury is, in other words, allowing PRC to do the “right thing” on their own, rather than our taking public a very good case against them. The world’s economic powers, the G-20, are assembling for a summit June 26-27 [Toronto], where it is known that the yuan will be discussed.
Early in the “miracle” of PRC’s economic rise, Beijing pegged the yuan to the dollar, officially stating that the yuan would trade at a fixed [by Beijing] number of dollars, regardless of its actual market value. They did this to stabilize their currency during what was going to be a turbulent era of dramatic change in the internal Chinese economy as they began to marketize society. They put a floor under the value of the yuan at the cost of prohibiting it from strengthening. This was needed to prevent the yuan from going into free-fall if the world lost faith in Beijing’s ability to reform their economy on the fly. A currency crash at the beginning of a restructuring would have proven fatal to the Chinese economy.
Insuring against collapse also comes with existential costs. As long as the yuan is actually worth less than the peg, it is over-valued, and that benefits the rest of the world – if my currency is actually worth more of your currency than you will admit, my goods and services are cheaper to you than they are really worth. It’s an indirect “subsidy” that helps my exports. This represents a downward pressure on the Chinese economy by making foreign goods and services artificially less expensive in the Chinese market, limiting domestic business and employment opportunities.
But Beijing’s rapid and skillful conversion to a more market-based economy proved wildly successful, strengthening the real value of their currency in the process. The yuan is now undervalued, and that benefits the Chinese economy for all the same reasons – it’s now their products that are “subsidized”, making them artificially cheaper in foreign markets, hurting those economies. The rest of the world is transferring net real wealth to PRC to the degree that the yuan is artificially cheap. This is true of trade, of Chinese foreign investment, and of foreign investment in PRC.
This is of more than academic interest because the World Trade Organization – a treaty organization whose arbitration signatories agree to honor – has a prohibition against tariffs and subsidies, and PRC is in material violation of that prohibition. The rest is political – getting a voting majority willing to chastise PRC. The usual remedy is an allowable tariff (but they call it an “excise”) to offset the subsidy, and the ice is broken for a trade war – everybody loses.
In these tough times, there is a lot of pressure to even the playing field vis-à-vis PRC so as to take pressure off of our job creation, hence the angst of lobbyists and Congressmen. In this case, the administration’s signature risk-averse foreign policy is not only the best approach, but also offers a useful window into the efficacy of our newly adopted Kumbaya international posture. Will our magnanimous gesture cause Beijing to “see the light” and allow the yuan to float? No. But they do have a two-month or so period during which they could allow the yuan to appreciate (without losing face), as they did from 2005 to 2008. This wouldn’t eliminate the subsidy, but the improvement in exchange rates would be noticeable. In any event, the problem will be discussed at the June WTO meeting, so Secretary Geithner is essentially kicking the can down that road.
It now boils down to how Beijing reads the politics involved – how many states can they bribe, browbeat and cajole into refusing to call a subsidy a subsidy, against how many we can bribe, browbeat and cajole into standing up to PRC.
This is the right type of problem that can be solved at the evolutionary pace of a non-robust diplomacy, as, unlike a nuclearizing Iran, there is no approaching “toggle” moment at which point the problem becomes insoluble.
In the interest of intellectual honesty and political fair play, I must offer kudos to a department secretary I consider ill-qualified and a mindset I consider ill-advised. When they’re right, they’re right … even if only twice a day.
 Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, ROK, Turkey, UK, US, and the EU make up the G-20.
 Beijing let the yuan rise 21% against the US dollar between July 2005 and July 2008 before effectively re-pegging it at ¥6.83 = $1.