What China's Currency Shift Could Mean

One cannot but help get a feeling of déjà vu following Timothy Geithner's current visit to Beijing to extract from the Chinese the minimal amount of exchange rate flexibility that will allow him to resist strong Congressional pressure to deem China a currency manipulator.

A modest currency appreciation is unlikely to reduce China's huge payment surplus, and that's a problem for the U.S.

Is this not what happened in July 2005 when China misled then-Treasury Secretary John Snow into believing that an initial move toward a more flexible Chinese exchange rate would be the start of better policy coordination between the two countries to address China's very large bilateral payment surplus with the United States?

There is little reason to believe that the modest currency appreciation now being proposed by China will be any more successful in reducing China's huge payment surplus.

China's modest currency appreciation between July 2005 and September 2008, which was unaccompanied by measures to promote Chinese domestic consumption, did nothing to slow China's rapid export growth or to halt its ballooning trade surplus with the United States.

There is little reason to believe that the modest currency appreciation now being proposed by China will be any more successful in reducing China's huge payment surplus. For the U.S., this has to be of greatest concern given the sluggish economy and the likelihood that unemployment will remain at close to 10 percent as midterm elections roll around in November.

Recently, Mr. Geithner judiciously delayed the issuance of the Treasury's currency report scheduled for April 15 to allow cooler heads to prevail in Washington and Beijing on the currency issue. One has to hope both for China's own sake as well as for the rest of the global economy that China takes advantage of this interval to move decisively both to a more acceptable management of its currency as well as toward meaningful structural reform to increase its very low level of domestic consumption. These policy changes would reverse what appears to be a dangerous and inexorable drift toward a protectionist backlash against China in both Europe and the United States.

But after five years of empty promises from China about understanding the need for a more flexible exchange rate system, one should not hold one's breath.

Desmond Lachman is a resident fellow at AEI.

Photo Credit: iStockphoto/Yong Hian Lim

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About the Author

 

Desmond
Lachman
  • Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund's (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and the multilateral lending agencies.
  • Phone: 202-862-5844
    Email: dlachman@aei.org
  • Assistant Info

    Name: Emma Bennett
    Phone: 202.862.5862
    Email: emma.bennett@aei.org

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