Letting China See the Light


Robert Nelson, BASC Research Assistant

This has been a week for deft diplomacy. Though the new Strategic Arms Reduction Treaty has been grabbing all the headlines in foreign policy circles, it is Treasury Secretary Geithner’s skillful handling of the Chinese currency crisis that deserves praise.

It seems all but certain that China will revalue its currency upward, and even let it float to some degree. Geithner pulled off his coup by keeping the whole problem at a distance and letting the situation develop under its own momentum. It would have been foolish for the Secretary to directly threaten China with a tariff or declare it a “currency manipulator.” Wisely, he let Congress do the dirty work. Meanwhile he constantly insisted that China’s currency policy was its choice, not his. By handling it in this way he managed to keep a stick on the table in the form of Congress, while also keeping an escape route open for China that would allow it to save face. Still, a question arises. Did Geithner force China into taking a position that will cause it pain, or did he accomplish the often all too difficult task of forcing a country to do something that is in its benefit?

It appears that he helped the Chinese help themselves. China’s policy of pegging the yuan to the dollar has become a bigger and bigger burden for the country to bear. Already the government spends 9.2 percent of its economic output on keeping the yuan and the dollar in line. If the dollar depreciates any further, this will become a much more outrageous expense.

Allowing the yuan to increase in value will also let China’s central bank more effectively respond to economic slowdowns, by giving it room to cut interest rates. In addition, letting the currency float, even a little, will allow the government to better respond to inflation. China’s inflation rate increased continually before the economic collapse, reaching a peak in 2009 of almost 6 percent. If China returns to growing anywhere near the rate that it did before the recession—and it seems likely that it will—the the government must be able to raise interest rates in order to cool down the economy. An increase in the interest rate will also keep high-risk speculative investments out of China.

Those in China who are skeptical of yen revaluation worry about the effects of an increase on Chinese exports. They argue that China’s economy is largely based on heavy industry and that an increase in the rate will make Chinese goods less competitive overseas. This argument ignores the fact that China’s economy is dependent on heavy industry and exports because of its low exchange rate. If the yuan were allowed to rise, the purchasing power of the Chinese consumer would also increase. This would result in a Chinese economy that is less dependent on demand from foreigners and a shift from heavy industry to the service sector.

Ironically, it appears that for the U.S., Geithner’s win will be a victory without spoils. The increase in the yuan is bound to be small and not enough to vastly decrease America’s trade deficit with China. The increase in the yuan will also not dramatically impact the cost of doing business in China, because while yuan revaluation would augment the already increasing price of labor, China’s investments in infrastructure have dramatically reduced communication and transportation costs. This means that any increase in wages will largely be offset. Nonetheless, if China continues to let its currency rise, U.S. industry will benefit in the long term.

Despite the lack of an obvious short-term gain for American industry, Geithner’s victory achieved the much more important goal of avoiding a trade war. A tariff on Chinese imports would likely not have resulted in China caving and changing its currency policy. Rather, the Chinese would have become more nationalistic and countered with a tariff of its own. We saw this tit-for-tat reaction when the U.S. imposed a tariff on Chinese tires last year.

Some may argue that Geithner does not deserve credit for China’s impending change in policy. They believe that China would have been forced to change on its own, if not out of logic, then due to pressure from other developing countries like India and Brazil who have been hurt by China’s devaluation policy. Essentially, they believe Geithner did nothing, but that’s exactly why he deserves praise. He was under immense pressure domestically to “get tough” with China, but he wisely saw that reality would force China to adjust its currency and that a bombastic U.S. Treasury Secretary would just put an arrow in the quiver of the Chinese industrialists who oppose revaluation. By holding firm, Geithner has managed to secure a deal that will benefit the United States, China, and the world.


Robert Nelson

About Robert Nelson

Robert Nelson is a fourth year Political Science and Economics double major at U.C. Berkeley. Prior to coming to Berkeley he worked for Congressman Jim Moran (VA-8) and the political strategist James Carville. He is interested in the role of international institutions in global affairs and the state of relations between Western and Eastern powers. Beyond his academic interests, he enjoys travel, acting, and fishing.

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