Arrogance and fear drives currency policy

SCMP Sunday November 22 2009

What drives China's currency policy? Is it arrogance, fear or a mix of the two? At present, China is behaving like a rogue state, the only significant trading country to insist on its right to peg its currency to the US dollar and to maintain controls on most movements of capital. The net result is not merely to help sustain the imbalances in global trade, which is at the root of financial instability, but to force the adjustment process not so much on the US itself but on to almost every other country. The pressure on some, such as Brazil, has become so great that they have had to impose short-term capital controls.

For now, other countries have been very polite, awed by China's size and success. But, for hypocrisy, it is hard to beat the chairman of the China Banking Regulatory Commission, Liu Mingkang , blaming the US for blowing new asset bubbles as it seeks to counter recession with ultra low-cost money and a weak dollar. For sure, that is happening. But look at Liu's own contribution - a bubble in China's property market driven by Beijing's extraordinary combination of low interest rates, mammoth oversupply of credit and a currency policy that, by definition, imports all the evils of US policy that so infuriate Liu. A weak dollar is not just a consequence of low interest rates but of a trade deficit that, though still half its peak, needs to fall further. Meanwhile, the yuan peg is re-igniting inflation in China, according to unofficial but unmassaged data.

Liu claims that a dollar peg is for stability. What hypocrisy - criticising the US, on the one hand, while demanding the right to a dollar peg on the other. Of course, the biggest reason for China's policy is a beggar-thy-neighbour effort to gain market share at the expense of the rest of the world.

Not since the Great Depression has the world witnessed such behaviour by a major player. Other countries could be justified in imposing surcharges of 10-15 per cent on all imports from China until it adopts a market-driven currency policy to match the market-driven trade access it has been accorded.

So much for the arrogance factor. Next is the fear factor. Surely a nation of more than a billion people cannot rely on marginal additional global demand provided by a rigged currency to sustain employment. If it does, then maybe its leaders have reason to fear their compatriots' wrath if promises of fast-growing wealth for all cannot be so easily delivered. Or, they will be outraged by the fact that a revaluation would mean the government had lost trillions of yuan by buying US dollars. Perhaps the media clamp on an innocuous 'town hall' appearance by US President Barack Obama in Shanghai illustrates the mix of fear and contempt with which the leadership views its people.

Maybe the leadership is also terrified of the consequences of a currency liberated from controls. The fear here is not really the trade consequences of an appreciation of, say, 20 per cent in the yuan's value against the dollar, and perhaps more against other currencies. That would most likely be the short-term result.

But longer term, dare the leadership contemplate a situation in which any citizen can have the same rights as a citizen of, say, Indonesia and invest overseas? Of course, it is easy for the well-connected to get some of their money out to safe havens. But, millions might want to hedge their bets, too. Currency outflows and yuan value might become a gauge of sentiment about the quality of government. What future, then, for a self-perpetuating party leadership?

China wants to have its cake and eat it. It wants to be acknowledged as the power that it is by having its currency used internationally. But it is unwilling to make that happen out of a mix of arrogance and fear. The currency is a defining issue for China. So far, a nervous leadership has shown that domestic considerations trump international ones.If it carries on in this way China should expect the retaliation it deserves.

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