Why Chinese Products Have Low Reliability
The ongoing dispute over China's monetary policy –
With the recently announced flexibilization of the renminbi, there are signs of an easing of the tension in the currency dispute between the USA and China. The discussion about China's monetary policy had only just regained heat. Five American senators had tabled a bill threatening China with punitive tariffs if it continues to keep the US dollar / renminbi exchange rate artificially low. US Treasury Secretary Timothy Geithner had already explicitly accused China of manipulating its currency last year. He suggested a tougher pace.1 China has been pegging the renminbi closely to the dollar for years, giving its export industry a competitive advantage over exporters, especially from the USA. Obama's goal of doubling American exports within five years will hardly be achievable in view of the Chinese competition.
But even in the light of the global current account imbalances, an appreciation of the renminbi is urgently required. The permanently low renminbi exchange rate exacerbates the discrepancy between countries with high export surpluses such as China or Germany and deficit countries such as the USA or Great Britain. The financial crisis has shown the fatal consequences of this development: with increasing deficits or surpluses, unsustainable imbalances in foreign currencies, capital market flows and yields arose. With them grew the need for financial market instruments that could flexibly cope with this enormous capital transfer from surplus to deficit countries. This laid the foundation for the emergence of more and more new types of financial market products, which made the jungle of the financial markets ever more opaque and the mutual dependencies ever greater.
From the point of view of exchange rate theory, the case is clear: just through the interventions of the Chinese central bank, the massive inflow of capital into China and the huge foreign trade surplus are possible in parallel. With a flexible exchange rate and free movement of capital, the external value of the renminbi would rise until the capital and current account balance each other and thus lead to an intervention-free balance of payments equilibrium. Instead, exchange rate interventions have resulted in China accumulating around US $ 2,400 billion in foreign exchange reserves in recent years, compared to just US $ 156 billion in 2000. Much of this amount is made up of US securities together, which the Chinese buy to keep their currency low against the dollar.
China's most recent announcement of flexibilisation is less likely to aim to reduce global current account imbalances than to pursue pure self-interest. Lower import prices due to the appreciation of the renminbi can make an important contribution to keeping inflation at the target level of 3%. The higher purchasing power strengthens domestic demand and reduces dependence on the export industry. This means that China is also putting pressure on its export industry to move from “quantitative” to “qualitative” growth, with the export industry focusing less - as before - on cost advantages and instead striving for progress in productivity and innovation. Because when labor costs rise, productivity has to be increased. This is the only way to make the change from a pure production location to an innovation location.
However, it is extremely questionable whether there will actually be a realignment of Chinese monetary policy. It would not be the first time China has promised to change its monetary policy without taking action. In any case, there can be no talk of a real release of the renminbi rate. The Chinese central bank, which sets the mean value of the renminbi exchange rate against the dollar on a daily basis, will only allow minor changes.
The IMF is too weak to tame China
It can be assumed that China's currency interventions will continue to be criticized in the future. The demand made by US senators a few months ago is aimed at establishing a “fundamental mispricing” of the exchange rate, on the basis of which anti-dumping duties are to be levied on Chinese imports. The proposal is one of earlier legislative proposals in the US that provided a measure against Chinese currency interventions to impose an ad valorem tariff on all goods from China.2 However, the US has not yet taken any unilateral measures. The danger of an open conflict is inevitable.
It would be more expedient to make currency interventions the subject of multilateral solutions within the framework of international organizations. At first glance, the International Monetary Fund (IMF) is the appropriate forum for monetary policy measures. It obliges its member states to refrain from fundamental mispricing and exchange rate manipulations in trade and balance of payments. However, the IMF agreement lacks a clear statement about what is meant by the term “manipulation of exchange rates”. Instead, only objective conditions are mentioned under which the IMF can enter into consultations with the member concerned. These include, for example, "the excessive and persistent official or quasi-official accumulation of foreign capital" or "extensive and persistent current account deficits or surpluses" .3 It is therefore clear that China is fulfilling at least some developments that suggest the need for consultation. However, a prerequisite for determining an exchange rate manipulation is always that the alleged manipulator is actually concerned with a manipulation from a subjective point of view. This is likely to be difficult to prove, since China's exchange rate policy could be based on a number of intentions that go beyond the pure increase in exports
But even if the IMF discovered that China was manipulating the exchange rate with the intention of gaining an unfair competitive advantage, the IMF would not have an effective set of sanctions at its disposal. The IMF can make recommendations that would also be binding for the IMF member. In the absence of enforcement powers, however, the IMF has proven to be a toothless tiger: for years the fund has been calling on China to loosen the renminbi's peg to the US dollar - so far without success. For without a qualified majority of the votes of the IMF members, the IMF could at best revoke China's right to use the general fund resources. With this authority, however, the IMF simply lacks the potential for threats, not least because China, thanks to its high foreign exchange reserves, is not dependent on the fund's credit lines. On the other hand, drastic measures, such as the suspension of voting rights and the induction of leaving the IMF, would require a qualified majority of 70 to 85%, which would also be politically unrealistic
Extension of the WTO rules
A solution within the framework of the World Trade Organization (WTO), whose rules are aimed at liberalization and non-discrimination in international trade, would be much more effective. Devaluation practices are not originally trade policy measures, but according to the objectives of the WTO, currency interventions must also be measured by whether they have a trade-restricting effect. A currency devaluation can have a significant impact on international trade flows. A currency exchange rate that is kept permanently below market equilibrium promotes export opportunities and limits the export opportunities of other countries.
However, under current WTO rules it is unclear whether they cover exchange rate manipulation. It is true that the WTO Agreement contains the express stipulation that WTO members “refrain from thwarting the purpose of the WTO Agreement by means of payment transactions or the purpose of the IMF Agreement by means of trade policy measures” interprets that the term “measures in payment traffic” only refers to “payment traffic policy” in the IMF sense, ie concerns the question of convertibility, but not exchange rate policy.7 Also, there has so far been no dispute settlement procedure within the framework of the WTO due to trade-distorting currency interventions .8 Finally, the frequently raised allegation that keeping the Chinese currency artificially low would in fact lead to export subsidies is not convincing under current WTO law. According to this, export subsidies are those subsidies “which enable these goods to be sold for export at a price that is lower than the comparable domestic price of a similar product”. However, exchange rate manipulation does not lead to a price difference between domestic and export prices.
If the current WTO regulations do not limit the exchange rate policy, an extension of the WTO regulations would be necessary in such a way that the trade disadvantages caused by currency interventions in other countries are considered to be contrary to the WTO. Such a ban could ultimately also be made the subject of a WTO dispute settlement procedure in which disadvantaged trading nations would be entitled to levy punitive tariffs. Because of their protectionist nature, sanctions are generally counterproductive - incorporating them into the WTO rules would, however, encourage disciplining currency interventions without ultimately having to result in punitive tariffs. In the case of a dispute settlement procedure, however, a considerable difficulty would be the determination of damage to the importing country, whose industry is suffering from the manipulated exchange rate. The exchange rate in line with the market and the level of undervaluation would have to be determined in a system of free exchange rate formation. A precise quantification of the effects of exchange rate manipulation on trade flows hardly appears possible.
In order to create legal clarity and to incorporate trade-distorting exchange rate manipulations into the WTO rules, the objective criteria for the definition of exchange rate manipulation, as provided for in the IMF rules, would have to be transferred to the WTO agreement. If the subjective intention of the exchange rate manipulation is proven, a reversal of the burden of proof would have to apply. Then, if the objective criteria are present and a procedure is initiated by another WTO member, the defendant state would have to provide evidence that plausible reasons justify the exchange rate interventions. The technical assessment of an alleged exchange rate manipulation would ultimately have to remain with the IMF, as it has more expertise on these issues than the WTO dispute settlement bodies.
Whether the expansion of the WTO rules is actually a realistic option depends largely on the political will of the member states. The stalled negotiations on new free trade rules in the Doha Round give no cause for optimism. On the other hand, a ban on currency overvaluations could be negotiated in a package with other concessions, for example on market access for agricultural or industrial goods, which would also make this point “negotiable” for China.
Fixed exchange rates or “de-dollarization” of the renminbi?
Politically, a return to fixed exchange rates would be even less likely. With fixed exchange rates, manipulation is more obvious and could therefore be prevented more effectively, but monetary policy autonomy would be forcibly given up. A flexible adjustment of the currency to macroeconomic developments would be ruled out.
Some experts therefore propose to allow certain fluctuations in relation to other currencies with a basically constant exchange rate, depending on the level of the inflation difference between the individual countries. However, this measure would be fraught with many technical difficulties. The more obvious - and from the Chinese point of view, the most likely compromise - would be a “de-dollarization” of the renminbi.9 The US dollar could be replaced by a basket of currencies made up of currencies from countries with intensive trade relations with China. Each currency would be weighted differently according to the volume of trade in China's total foreign trade. This would leave at least some room for decoupling between the US dollar and the renminbi, which could ease the bilateral current account imbalance between China and the US.
But the US should also realize one thing: if the Chinese implement the announced flexibilisation of the renminbi, China will restrict its massive purchases of US government bonds on the capital markets. In times of financial and economic crisis, the US was to a large extent dependent on the Chinese central bank to buy US government bonds. The US would lose a reliable financier of its debt mountain. Interest rates threaten to rise and new debts become more expensive - this would increase the pressure to reduce the American budget deficit.
- 1 Jackie Calmes: Geithner hits at harder line on China, in: The New York Times, January 23, 2009.
- 2 So-called Schumer-Graham-Bill (2003) or Ryan-Hunter-Bill (2006).
- 3 IWF Public Information Notice (PIN) No. 07/69, p. 2.
- 4 Christoph Herrmann: Don Yuan - China's selfish exchange rate policy and international business law, in: Archiv des Völkerrechts, Vol. 48 (2010), pp. 132-159, here p. 149.
- 5 Joseph Gold: Legal and Institutional Aspects of the International Monetary System: Selected Essays, Washington 1979, p. 148 ff.
- 6 See GATT Article XV: 4.
- 7 Christoph Herrmann, op. Cit.
- 8 See WTO: Note by the Secretariat, WTO Provisions Relevant to the Relationship Between Trade and Finance and Trade and Debt, WT / WGTDE / W / 3, p. 13 ff.
- 9 China has also permitted this to a limited extent in the past. Michael Funke, Marc Gronwald: The undisclosed renminbi basket: Are the markets telling us something about where the renminbi-US Dollar exchange rate is going ?, Bank of Finland, Discussion Paper, 2007.
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