Flying high - but will it float? Its economy rampant, China could soon bow to global pressure and free its currency, writes Heather Stewart
Sunday November 21, 2004 The Observer 'China is a sleeping giant. And when she awakes, she shall astonish the world.' The truth of Napoleon's warning, made more than two centuries ago, is beginning to resonate in the world's richest nations. When oil prices shot up above $50 a barrel earlier this year, it was the latest signal that, finally, China is living up to its potential as one of the world's great economic powers: when Beijing and Shanghai put their foot on the gas, the effects ripple throughout the global economy. But taking a bigger part in the world economy has its price. China, the world's last great communist state, which has gradually evolved its own version of capitalism, is facing unprecedented pressure from the US and Europe to play by their rules, and float its currency, the renminbi, on the foreign exchange markets. Some analysts believe recent moves by Beijing, including the first increase in interest rates for nine years, could presage a shift in currency strategy, perhaps as soon as the Chinese Communist Party's annual economic work conference at the end of this week. Li Ruogu, the deputy central bank governor, was quoted last week as saying China had 'made a host of fundamental preparations and achieved active progress' towards making its currency fully convertible, a stated long-term aim for some years. China has experienced an extraordinary boom since the late 1990s, consistently expanding by close to 10 per cent a year. Over 20 years, per capita income has almost quadrupled. Its passport to the global marketplace was firmly stamped in 2001 when it joined the World Trade Organisation, accelerating its integration with the rest of the world. In 1990, China's exports to the US were $5 billion. By last year, the figure was over $92bn. The US ran up a $15bn trade deficit with China in September alone. Yet while the dollar is plunging against the euro, hitting a record low last week as investors fretted about the vast imbalances between the US economy and the rest of the world, the greenback cannot move against the renminbi. Like the US and Britain in the post-war Bretton Woods currency system, China doesn't allow the renminbi to float freely against other currencies: it has 'pegged' it against the dollar, helping to protect it from the whims of the foreign exchange markets while it slowly opens its markets up to the rest of the world. But patience with the currency peg is running out, particularly in the US. Blaming people in far-off countries for troubles at home is always a tempting strategy for politicians, and China, with its stubborn independence of mind and refusal to conform to economic orthodoxy, has become the scapegoat for many of the woes of the world's biggest economy. During the US presidential election campaign, both candidates lashed Beijing for the 'unfair' competitive advantage it gains through the currency peg. Angry Republican Representatives with constituencies in the rust-belt have presented a bill to Congress calling for sanctions against China, to punish it for 'manipulating' its currency. And there have been demands from unions for the White House to bring an action against China at the World Trade Organisation for using its currency as an unfair 'subsidy' of its goods. At the last G7 meeting of finance ministers in Washington, the Chinese, not official members of the rich-country club, were invited along to be lectured about why they should float the renminbi. Linda Yueh, of the London School of Economics, points out that the knee-jerk reaction against the Chinese over-simplifies the issue: more than half of Chinese exports are from foreign-owned companies, many of them American, which would suffer if an appreciation in the renminbi made them less competitive. Exposing the currency to the markets before dealing with the indebted banking system could be dangerous, she adds. 'China couldn't feasibly make its currency more market-oriented until it completed reforms in its banking sector.' The damage inflicted during the Asian financial crises of the late 1990s exposed the potentially devastating effect of violent currency movements on developing economies. Graham Turner of GFC Economics agrees that China needs to be cautious. 'It's not just about relative exchange rates, it's about the whole banking system. Under the WTO rules they've got to move away from the peg, but they're likely to do it slowly.' For the time being, according to Christian Weller, senior economist at the Centre for American Progress, turning up the heat on America's Asian competitors is the least-bad option for the US, and perhaps for the global economy. 'If you look at the numbers, trade deficits in the US are not sustainable at the current level. You need to have an adjustment,' he says. But he is concerned that one likely adjustment mechanism could be a US slowdown, with a vicious circle of weak consumer demand leading to weak job growth leading to even weaker consumer demand. And that, in turn, would be bad for China. 'We have to convince the Chinese that in the long run it's in everybody's interests to help stabilise the US,' says Weller. And he points out that because the trade gap with China is so much larger - and its economy is growing so much more quickly - than the sickly eurozone, the US would get 'more bang for its buck' from a decline in the dollar against the renminbi. Eurozone policymakers are becoming increasingly nervous about the strengthening single currency. Germany and France rely strongly on their export sectors to create growth and they fear a rising euro could knock the nascent economic recovery on the head. John Snow, the US Treasury secretary, was in Europe last week urging his counterparts to create a stronger growth climate at home instead of carping about the fiscal imbalances which have helped force down the dollar. But for now, that looks like a faint hope. So both the US and the eurozone are turning to Beijing to help them out of a hole by accepting a stronger currency in exchange for a reduced risk of a long period of depressed global demand - or worse, a dollar crisis. And Turner says there is also a 'darker' interpretation of US motives, in which the economics of the issue are less important than old-fashioned geopolitics. 'You really have to look at what the second Bush administration will stand for,' he says. 'And from a lot of things we read, it looks as though they see China as their biggest long-term threat: it's not al-Qaeda, it's the rise of another economic super-power with nuclear weapons. They're not going to allow China to continue growing at the expense of American manufacturers, it doesn't fit with the Bush doctrine.' As far as China's domestic economy is concerned, a change in currency strategy may look less urgent, with its boom already apparently coming to an end. As well as the rise in interest rates, surging oil prices, which were partly caused by unprecedented demand in China, will have taken their toll. Gabriel Stein, of Lombard Street Research, believes the 20 per cent fall in oil prices since their peak shows that a slowdown is already under way. China has shown itself to be impervious to pressure from the G7 to risk a float; but the signals from Beijing suggest there has been a shift in mood. Analysts believe China is likely to adopt a gradualist approach, perhaps shifting to a wider band instead of a peg - or linking itself to a basket of several currencies instead of the dollar alone. But under the intense gaze of Washington, China could, as soon as this week, take the next, momentous step in its long journey towards full membership of the global club.
