Despite holding off from formally designating China as a currency manipulator in its semi-annual report to Congress on economic and foreign exchange policies, the US Treasury issued an unusually trenchant and lengthy criticism of Beijing’s FX policy.
Whereas in past reports under both the Bush and Obama regimes, the Treasury’s criticism has been tempered by an emphasis on the signs of progress China has made in reducing the undervaluation of the renminbi, the latest report suggests the Treasury believes Beijing has abandoned the notion of meaningfully strengthening its currency.
The Treasury noted that the renminbi is appreciating on a trade-weighted basis, but “not as fast or by as much” as is needed and that Chinese FX intervention has resumed on a “large scale”.
Noting that official Chinese data showed that the People’s Bank of China and Chinese financial institutions collectively purchased a record $110 billion in foreign exchange in both January and September, the Treasury issued a reminder that China had committed to reduce the pace of its reserve accumulation and increase the transparency of its exchange rate policy at the 2012 G20 leaders’ summit in Mexico.
“The evidence that China has resumed large-scale purchases of foreign exchange this year, despite having accumulated $3.6 trillion in reserves, which are more than sufficient by any measure, is suggestive of actions that are impeding market determination and a currency that is significantly undervalued,” the Treasury said.
The Treasury also criticised the fact that China does not disclose its intervention activities in a timely manner, instead leaving observers to estimate Chinese intervention using published reserve levels.
“In line with the practice of other G20 nations, China should disclose foreign exchange market intervention regularly to increase the credibility of its monetary policy framework and to promote exchange rate and financial market transparency,” the Treasury said.
Plainly, the US feels the need to send a message to China over its currency policy.
Quite why the Treasury has chosen now to increase the pressure on China over that policy is open to debate. It comes, however, as the arguments over the renminbi’s undervaluation are breaking down.
The Treasury cites the most recent IMF consultation with China, at which the IMF concluded that the renminbi was moderately undervalued against a broad basket of currencies. It also cites the IMF’s Pilot External Sector Report, which estimated that the renminbi was undervalued by about 5% to 10% on a real effective basis as of July.
However, not all agree with that assessment.
Economists at Lombard Street Research, for instance, believe the renminbi is now 30% overvalued on a trade-weighted basis.
| Real effective FX rates |
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| Source: Lombard Street Research |
They say China has given up some of the competitive advantage it had because of wage growth and because the renminbi has been appreciating.
Indeed, Lombard Street says the US has clawed back 30% of the competitive disadvantage it had against China in recent years. That is because in the US there has been no wage growth, whereas in China there has been three years of pay increases above 10%.
Charles Dumas, chief economist and chairman of Lombard Street, says the combination of a rising currency and wage growth puts pressure on Chinese premier Li Keqiang's stated ambition to prevent growth from falling below 7%.
Dumas says with Chinese wage inflation currently at 11% and productivity growth at 7%, unit labour costs are rising at 4%. Dumas notes, however, that industrial prices are still falling by about 1.5% as Chinese industry copes with the rising renminbi by cutting prices to stay competitive.
“Margins are hammered by wage inflation, which is spurred upward by the government’s stimulus programmes that are largely wasteful,” says Dumas. “On our calculations, China is already more than 30% overvalued in terms of unit labour costs, and its competitors, notably the US, do not have anything like these sorts of wage increases, let alone a rising currency.”
| Chinese average wages and PPI, annual % change |
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| Source: Lombard Street Research |
On that basis, there would appear to be little incentive for US manufacturing to relocate to China, raising the question of quite why Washington has chosen now to intensify its attack on Beijing’s currency policy.
Perhaps the US is simply getting its retaliation in first, attempting to deflect criticism over its perceived neglect of the dollar as the prospect of the Federal Reserve tapering the purchases under its quantitative easing programme has diminished and undermined the US currency.
More likely, however, is that this is a nudge from the US to China’s new leadership to remember the interests of its main export market when contemplating its plans for economic reform.