U.S. and Euro zone arguments

Both the U.S. and the European Union now want China to abandon its policy of pegging the exchange rate of its currency, the yuan, against the U.S. dollar at a fixed 8.28 units. They have called for a revaluation of the yuan, commensurate with China's enhanced (and still growing) stature in the international economy.

First, the U.S. argument. This is not difficult to understand. America wants the yuan to be revalued so as to make Chinese goods costlier for American consumers and thereby make domestic goods more saleable. This, in turn, is expected to support domestic production and thereby help in the retention of domestic jobs.

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The numbers here are quite significant and seem to support this argument. China has now emerged as the second largest trading partner of the U.S. after Japan. More importantly, it accounts for 20 per cent of the U.S. trade deficit and ranks first among nations with which the U.S. runs trade deficits. (For instance, the US has posted a trade deficit of $250 billion in the six months to June 2003 and China's share in that is $ 54 billion. This is higher than Japan's share at $ 32 billion and Germany's $19 billion).

As for the structural composition of the trade deficit, here too the trends appear to be turning adverse for the U.S. For long, one thought that the Chinese were dominant exporters of textiles, light engineering goods and toys to the U.S. market. Recent developments suggest that even manufacture of medium and heavy industry (with critical job potential) may be shifting into the low-cost base of China. Caterpillar, the world's largest maker of earth-moving equipment, recently went on record that a manufacturing base in China as a global supply base could be crucial for the company going forward. Global automakers such as General Motors and Daimler-Chrysler already have a full-scale manufacturing presence in China. (On a more macro plane, it is estimated that more than 50 per cent of all manufactured goods that Americans buy now are imported, up from around 30 per cent in the mid-1980s).

America does not have the time for structural adjustments of the type which can provide more than a transitory cure for its bulging trade deficits. More so with the Presidential elections due in 2004. Exchange rate adjustments are therefore seen as a panacea, even if only for the short-term.

The E.U. argument for a higher Chinese yuan is more interesting. A pegged Chinese currency against the U.S. dollar means that the Euro (the common European currency) is taking a disproportionate burden of adjusting for the massive US trade imbalance. That is, with the yuan not revaluing, the Euro has been revaluing also for it, in addition to any inherent forces that may be pushing the Euro higher against the dollar. And, of course, for major manufacturer exporters such as Germany (the locomotive economy in Europe), a strong Euro is a major bugbear.

The numbers here bear some emphasis. While the yuan has remained pegged at 8.28 against the dollar, the Euro is up more than 25 per cent in the past year and a half — it has zoomed from just around 89 U.S. cents early in 2002 to around 1.13 U.S. dollars now.