The currency war and after

Hasnat Abdul Hye   | Published: September 26, 2018 21:14:05 | Updated: September 30, 2018 21:00:14

Behind the belligerent rhetoric against China over alleged unfair trade practices and slapping of mounting tariff on Chinese export to America, the spectre of a long-drawn-out war has been eclipsed. But that is a momentary illusion, given the continuity of American monetary policy through successive American administration to maintain dollar's value. Contrary to its public posture and pronouncements, America has been carrying out a currency war against China since long. Its collateral has affected a number of other countries, particularly those with emerging economies. When America accuses China for manipulation of its currency to gain unfair trade advantage, it sounds not only hollow but downright hypocritical. A review of its monetary and trade policies and economic diplomatic moves in recent years leaves no doubt about this fact.

The currency war waged by America under various guises is prefaced by claims of Chinese under-valuation of their national currency, renmenbi. Paradoxically, in the 1990s the Peoples' Bank of China (PBOC), the central bank of the country, was being berated on regular basis by the US Treasury for maintaining an overvalued currency. This changed when China adopted an export-led growth strategy and carried out a number of devaluation measures until the Asian Financial Crisis of 1997 that sent a number of South-east Asian economies into tailspin. After putting on hold its policy of gradual devaluation until the financial crisis was over, China resumed the new monetary policy of gradual change in the exchange rate that was pegged to US dollar. Almost with a knee-jerk reaction the US Treasury cried foul, levelling the Chinese monetary policy as tantamount to currency manipulation. That was the last time that American administration publicly used the 'M' word against China until President Trump mentioned it on several occasions after assuming office. No credit was given to China for holding on steadfastly to a stable exchange rate during the Asian Financial Crisis to prevent spreading of contagion from the same and to facilitate the recovery of the economy of the countries affected. No sooner the Asian Crisis is over than a policy of low interest rate was announced by the US Federal Reserve Bank (Fed). It was ostensibly to fend off deflation in America but the underlying objective was to contain Chinese exports that were increasing in volume every year. The move by Fed sowed the seeds of the full-scale currency war that would be unleashed by America from the beginning of the new millennium. The low interest rate of Fed became the pivot of the post-2008 bailouts of financial institutions and the Quantitative Easing (QE) policy that were undertaken by American administration for the recovery of the economy. The new economic policy in the form of QE began in 2009 when the Fed started printing money to monetise government deficits, whether they arose from tax cuts or increase in public spending. In justification of the unconventional monetary policy the Fed mentioned that it was necessary to cope with deflation and alleged that China was the most important source of that insidious economic malaise. The growing volume of Chinese exports that exacerbated American trade deficit with that country was given as an additional argument to strengthen the case for QE. According to statistics released, American trade deficit with China had ballooned from $50 billion in 1997 to $230 billion in 2007. It was asserted that to cope with the deficit QE was necessary. In pursuance of this policy the Fed started printing money on a larger scale than in the past. The bulk of this printed money ended up with the Peoples' Bank of China which accepted dollar from Chinese exporters in exchange for yuan (the local name for renmenbi) that was printed to meet the growing demand. The Chinese Central Bank had no other option than to print money because of the need to maintain the pegged exchange rate with dollar. In effect Chinese central bank outsourced its monetary policy to the Fed which the US Treasury wanted in the first place as per the blueprint for the currency war against China. As if this was not enough of a problem, the Chinese central bank acquired massive quantities of US Treasury securities through investment of the surplus dollar reserve resulting from trade with America. When the Fed lowered interest rate the return on these securities dwindled precipitously but the Chinese central bank could not dispose of these assets in the absence of better alternatives. China became stuck with US treasury bills worth over a trillion US dollar. Thus the country was dealt with double whammy by Fed, firstly spiking inflation with printed dollar that was paid to the Chinese exporters and secondly, with the stock of US securities with the Chinese central bank that became undervalued through lowering of interest by Fed. The Chinese found themselves at the wrong end of a currency war that was imposed on them.

Following its blueprint of hemorrhaging the Chinese economy through currency war, American administration kept on pressuring China to revalue renmenbi downward on the ground that it was overvalued. But to protect the pegged exchange rate China could not devalue to a degree that was wanted by America. Rather, its interest lay in opting for revaluing renmenbi upward. So gradually the dollar value of renmenbi was increased by the Chinese authority to protect its interest. This irked the American administration and led it to devise more aggressive measures against China. Though the growing trade deficit continued to be the 'elephant in the room', the American economy faced no impending crisis. The low interest rate and policy of cheap money adopted from the time of Bush administration kept the wheel of the American economy moving smoothly. That is until the financial crisis of 2007 struck almost out of the blue. The American economy almost stuttered to a halt. Mortgages remained unpaid, equities lost their value, bonds became junk and one financial institution after another started to fail and quite a few manufacturing firms became bankrupt. As unemployment rose, consumer spending declined compounding the problem in the real economy. The Great Recession of the new millennium appeared on the horizon, casting gloom all around. To find a scapegoat, the American administration cried foul and blamed China for the financial crisis pointing out that the undervalued Chinese currency was the main cause for the financial meltdown. But realising that discretion was the better part even in a currency war, President Bush and later President Obama opted for economic diplomacy, thus opening the second front in the currency war against China.

Using a bilateral forum under the name of Strategic Economic Dialogue, the American Treasury officials engaged with their Chinese counterparts to find wage and means of whittling down trade deficit. These bilateral talks succeeded in keeping US-Chinese currency tensions under control. But America wanted more concessions from China for which it did not pin much hope on negotiations with the Chinese. It turned to G-7 as a possible forum to corner China. With that end in view the membership of G-7 was expanded to 20 which included China among others. This forum helped to avoid escalation in tensions over the currency manipulation charges against China. But it did not make the problem disappear and turn the currency war into a matter of the past. In addition to mobilising the support of other members of the G-20 in favour of its agenda for what was called 'rebalancing' of global economy, the help of IMF was also sought to oversee the compliance by all countries with the agreed decisions regarding trade and exchange rate. Under pressure from majority members of G-20 China had to agree to devalue renmenbi but not to the same degree as desired by America in pursuance of its policy of rebalancing, a euphemism for promotion of American economic interests. America realised that to achieve the goal of increasing exports to China either dollar had to be cheaper or China had to import more following a policy of devaluation of renmenbi. But with almost zero-interest rate there was no scope for dollar to become cheaper. Hence, renewed pressure was put on China, both bilaterally and through the G-20, to devalue renmenbi.

Under pressure China responded by devaluing its currency but again not to the same extent as wanted by America. It was insisted that all member countries should devalue if their trade surplus exceeded 4.0 per cent of GDP. But this American proposal was not agreed to not only by China but by other member countries also. Frustrated at the minuscule change in the exchange rate of China, America used a new weapon in 2010, naming it as quantitative easing. It was a reincarnation of the policy of easy money purused in the recent past with near zero interest rate. But this time around there was a big difference with the past, the Fed started printing money to lend to banks at near-zero interest. The new policy spiked inflation in China through payment in dollar to Chinese exporters, as has mentioned earlier. The cost of goods manufactured went up in the exporting countries, including China, because of inflation that diminished their competitiveness. At last, the goal set by America appeared within its reach. Quantitative Easing became the preferred weapon in the currency war, particularly with China. This weapon remained a pivot of the policy for rebalancing the American economy from 2009 to 2017 when it was winded down as inflation threatened American economy. But when it was in force it had devastating effect on China's policy of maintaining its exchange rate pegged to dollar. The Fed's monitory policy delivered what cajoling and coercing failed to do.

As if the success in the currency war was not enough of a satisfaction, the Trump administration has now come down heavily against countries like China having trade surplus with America, slapping massive amount of protective tariff. If the currency war bled countries like China drip by drip, the slapping of tariff in quick succession has changed the course of the global economy overnight, threatening it with destabilisation. In the currency war America's approach was subtle and painstaking. In contrast, the trade policy articulated through stiff tariff has been blunt and brutal. If this policy continues America may not need to pursue currency war, with China or any other country in the near future.




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