Politics & Policy

Brother, Can You Spare the Yuan?

Conventional wisdom says Obama should press China to revalue the yuan. Wrong.

The watchwords for next week’s meeting between President Obama and his Chinese counterpart, Hu Jintao, are “balanced” and “sustainable” when it comes to economic relations between the U.S. and the PRC. Senior administration officials are already laying the groundwork. On November 6, Deputy Secretary of State James Feinberg told a gathering in Washington, D.C., that Asia “needs balanced growth,” noting that the “region depends heavily” on having “a dynamic and open trading system.” That same day, a senior National Security Council official, Jeffrey Bader, told an audience at the Brookings Institution that, before the current economic crisis, “Asian countries — notably China — were exporting large amounts of goods to the United States.That is not a sustainable model and we have been very clear to the . . . Chinese government about that.”

These comments reflect concern with China’s massive trade surplus, driven in part by the artificially undervalued yuan. Administration officials are signaling that they intend for President Obama to pressure China to revalue its cheap currency, which the New York Times’s Paul Krugman calls a “growing threat to the rest of the world economy.”

#ad#In fact, in preparing for his meeting with President Hu, Mr. Obama would do well to follow the example of Ronald Reagan in his historic meeting with Mikhail Gorbachev in Reykjavik 23 years ago last month: He should ignore the conventional wisdom and many of his own advisers.

There is pressure on presidents for “deliverables” when they engage in summitry. The Reykjavik deliverable was a significant arms reduction, but Reagan passed when he learned that the price was giving up on missile defense. In time, Reagan was rewarded for his patience by achieving deep cuts in arms while not abandoning missile defense.

For Obama, the deliverable is “balance” in the form of a revalued yuan. President Obama should read the fine print before signing on to this goal.

Rejecting the conventional wisdom about China’s currency starts with rejecting the conventional wisdom about China’s economic growth, which appears to have recovered after dipping to nearly zero at the end of 2008. Beijing has reported a July–September growth rate of 8.9 percent. But this is an artificially inflated number, the result of massive government spending: On a pro-rated basis, Beijing has spent three times as much as the $757-billion U.S. stimulus package. According to Bloomberg News, the World Bank estimates that government support will account for more than four-fifths of China’s growth this year. As Gordon Chang aptly described it in Forbes, the third-quarter growth figure represents a government-induced “sugar high.” Michael Pettis of Peking University told Bloomberg it is “growth on steroids.” Notes Pettis: “The question now is how to stop pumping so much money into the system without a sharp reduction in growth.”

Into these roiling waters wades the Obama administration to pressure China for a currency revaluation, seeking more favorable terms of trade for U.S. products. But the principal beneficiary of China’s surpluses is the American consumer, who doesn’t find it distasteful to pay lower prices for goods. The administration sees it differently, however. The NSC’s Bader warned that China should not seek to achieve “prosperity based on the profligacy of the American consumer.”

#page#Blaming China’s undervalued currency for U.S. trade deficits is, according to Morgan Stanley Asia Chairman Stephen Roach, a “red herring.” Yuan revaluation will not reduce the U.S. trade deficit; consumers will simply find what they seek from other, less efficient producers, who will benefit from China’s slowdown.

More broadly, though, the global economic recovery is fragile. Plenty of analysts are warning of a W-shaped recovery, with another decline before there is a return to sustained growth. While the world finds hope in  China’s high third-quarter growth, there seems to be little appreciation that — leaving aside the question of government spending — the Chinese economy is not capable in the foreseeable future of generating such growth in any way other than through exports. As it is, the export figures are not what they were. At their high point prior to the current crisis, exports accounted for as much as 40 percent of Chinese GDP. For the first half of 2009, exports were down nearly 22 percent year over year. Revaluation of the yuan would accelerate the decline in exports, put downward pressure on growth, and almost certainly contribute to China’s already serious unemployment and instability.

#ad#In the longer term, China is caught in a conundrum. As countries develop, they move away from low-value exports. Nearly 25 percent of China’s exports are textiles and base metals; this compares with 10 percent of Japan’s exports and 15 percent of South Korea’s. China’s particular challenge is its vast size compounded by its poverty. Nominal per capita GDP is only $3,300 (about one-15th that of the U.S.); it is certainly much lower in the dirt-poor rural regions. This urban-rural disparity will only be exacerbated as officials attempt to nudge the economy away from cheap exports and toward greater domestic consumption and value-added manufacturing. These disparities will create large internal population shifts, putting great stress on China’s fragile infrastructure, the environment, and social services ill equipped to handle it.

Falling exports during the global recession have already provided a glimpse of this. The number of working-age people in urban areas is down by some 50 million since the economic peak in 2007. As exports and foreign investment fall, urban laborers are returning to their rural home regions by the tens of millions. This is putting pressure on rural areas, where unemployment is already very high and incomes are very low. Internal migratory flows equal to the entire population of South Korea are China’s own version of imbalance and unsustainability, quite apart from what the U.S. and the rest of the world are concerned about.

President Obama’s hosts in Beijing understand that China needs to wean itself from low-value exports as a source of economic growth if it is to modernize. This is not a matter of currency valuation but of long-term structural change in the Chinese economy. At present, China is caught in complicated economic cross-currents. Domestic consumption would have to increase dramatically thr oughout the country to offset the drop in exports. But with per capita income as low as it is, how much can Chinese families realistically be expected to increase their spending? The need for greater domestic consumption also is at odds with China’s relatively high savings rate, a product of a culture and a society where people must rely on themselves and their families, given scant government-backed social welfare and the lack of other public safety nets that exist in more advanced economies. Most ominous for those in power, a dramatic rise in domestic consumption could be achieved only through much greater economic, regional, and market liberalization, which is anathema to the country’s leaders, who are, let us remember, still Communists.

With the U.S. generating fiscal deficits as far as the eye can see — creating ever more costly entitlement programs that will sap future productivity through higher tax rates — and with stubborn structural unemployment of more than 10 percent, now is probably not the time for the American president to lecture China about its economy. Far from the “engine of growth” that some believe the Chinese economy is, it actually is a rickety structure that cannot withstand much pressure, from inside or outside. We remain in the “do no harm” stage of the economic cycle. Pressure for China to revalue its currency and threats of greater trade protectionism can do great harm indeed. We must hope that President Obama will pull a Reagan, disregard the conventional wisdom, and — like Reagan — reap the long-term reward from avoiding the illusory quick fix.

– Therese Shaheen is chairman of U.S. Asia International, a consulting firm that does business in Asia.

Therese Shaheen is a businesswoman and CEO of US Asia International. She was the chairman of the State Department’s American Institute in Taiwan from 2002 to 2004.

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