Until 1983, the Renminbi (RMB) was quite overvalued, rated at a proportion of 2.8 RMB per US Dollars (USD). By then, Chinese exports represented only a few fraction of China’s GPD, the focus was on cheap imports aimed at infrastructure development. By the late 80’s the exporting sector was growing at a faster pace and China underwent a process of monetary devaluation until the Renminbi reached the price of 8.28 RMB/UDS, that valuation was maintained from 1997 to 2004. China was often called “currency manipulator” with the goal of gaining some advantages in international trade.
From 2005 onwards, the problem of the Chinese surplus over the United States’ (US) economy became more and more noticeable. That, combined with the fact that Renminbi has been pegged to the USD, was producing a negative effect on the US, which came from the transmission of Chinese deflation onto its economy, mostly through cheap labour.
For the People’s Republic of China (PRC) the Renminbi being pegged implied the absorption of the UDS surplus flowing into the country. The People’s Bank of China (PBC) by keeping USD had to buy them with newly printed RMB, therefore, whenever the Federal Reserve Bank (FED) printed UDS they would end up in China for the purchase of goods. This means that China, by not having a liberalized capital account, had no control over its monetary policy which was ultimately controlled by the FED. As a result, the PBC had too many UDS in its possession which had to be invested in safe financial instruments, usually associated with US Treasury Bonds (TB), so the PBC eventually acquired a huge amount of US TB.
China has been in a lot of pressure by the US in order to increase the value of the Renminbi, reducing the US trade deficit and the accumulation of US denominated assets by China. From 2005 to 2008 there was a series of revaluations until the RMB reached 6.82 USD, after that it stagnated for a while. In 2010 another period of revaluation started and today the valuation is around 6.4 RMB/USD.
The US is dependent on China as well. The FED is now making arrangements to reduce economic stimuli (tapering) which have been in place as a contra-cyclical measure towards the crises. However, the loosen up of the interest rate level might not be just a consequence of a deliberate decision by the central government, but also a market reaction to international events: the growing discomfort in the PRC because of the great exposure to US financial assets is an incentive to the selling-off of US financial assets, that would trigger a rising trend on US interest rates despite the tapering policy. The negative effect is that the FED would not be able to monetize all the debt because it would imply too much inflation.
What I wish to emphasize is that there is a currency war game between the US and China, if China revaluates, it loses competitiveness advantages, when exports are the major contribution to growth and especially to employment in China. It would also mean that the US liabilities owned by the PBC as reserves would represent a lower amount in RMB, which is good for the US and bad for China. However, revaluating is needed if China wants a smooth transition to a more liberal capital account in the future. On the other hand, an undervalued currency pegged to the USD also poses a risk as long as capital controls are in place, which is the big exposure to US financial products. Since China having a cheap currency is bad for the US economy, the US government can react by imposing some restrictions to bilateral trade harming Chinese exports but a policy like that would have potential repercussions from the World Trade Organization (WTO). If in turn the US does nothing, its trade deficit, assuming it will continue to increase, will represent an even higher amount in RMB terms.
Bottom line, there is never complete information on one another’s possible responses and there are lots of constraints, for instance, moves are subject to public scrutiny. Furthermore, these countries are linked by billions of dollars, so, each step in the game would have massive impacts on both economies. As for the outcome, it is rather unpredictable, I suppose that China will slowly move to a liberalized capital account, implying the revaluation of the Renminbi, and that the US would not have to impose any restrictions on trade.
Carolina Conde Rodrigues
Rickards, James (2014), Currency Wars – The Making of the Next Global Crisis, Penguin Publisher