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Gordon G. Chang lived and worked in China for almost two decades. He is the author of two books, including The Coming Collapse of China. His writings have appeared in The New York Times, The Wall Street Journal, the International Herald Tribune, and Barron's, among other publications. He also writes a weekly column for Forbes.com.
Beijing, apparently reacting to international pressure, has hinted that it will allow its currency to get stronger. The latest indication may be the most significant. President and General Secretary Hu Jintao, in comments released April 16 by the Ministry of Foreign Affairs, said his country will soon adopt a new system of pricing the yuan. "We have always moved toward implementing a managed floating exchange rate system based on principles of acting on our own initiative in a controlled and gradual manner," said Hu, speaking at the BRIC summit in Brazil.
The first two elements of that statement are extremely misleading. First, Beijing has most recently been moving in the wrong direction on the yuan. China, which had fixed its currency to the dollar for years, implemented a one-off revaluation of 2.1% in July 2005 and then allowed a managed float. By July 2008, the yuan had risen a further 19%. Then, however, Beijing went back to repegging the currency to the greenback to help China's beleaguered exporters. Currently, the People's Bank of China, the central bank, buys and sells currency to maintain a fixed rate of about US$1 = CNY6.83.
Second, Beijing, despite what Hu would like us to believe, liberalizes currency policy only in response to foreign pressure. The only time it acts on its own initiative is when it backtracks on reform.
Hu Jintao's third point -- China moves in a controlled and gradual fashion -- is certainly correct. The Chinese, after all, are world champions when it comes to acting at glacial speed. So the question is this: How slowly will Beijing move to strengthen the yuan? Now, the currency trades -- if we can speak of the yuan being "traded" -- at a discount of 40%, perhaps more.
Of course, we will know the full extent of the currency's undervaluation only when Beijing allows it to float. Clearly, the pressure is building on Capitol Hill to force China to do so, or at least to revalue. Senators Chuck Schumer, the New York Democrat, and Lindsey Graham, the South Carolina Republican, would impose various penalties on China if it maintained a misaligned currency, but Beijing has outmaneuvered the pair for years.
Yet there is one Michigan Democrat that the Chinese may need to accommodate. On April 19, House Ways and Means Chairman Sander Levin said he would act if China did not. He then gave President Obama and Treasury Secretary Geithner -- another pair the Chinese have easily manipulated -- until June to achieve results.
The G-20 convenes in Toronto that month. Previous meetings of this grouping have achieved nothing, but Chairman Levin is willing to be patient so that the administration can persuade the Chinese to move.
The problem is that China's political system can't seem to move at this point. The consensus required for major decisions is, unfortunately, lacking, as officials are still arguing in print -- and behind closed doors -- about what to do. And in the run-up to a major leadership transition supposed to occur in late 2012, it is difficult for anyone to take significant steps, especially ones Washington wants. For years, Chinese technocrats knew they needed to allow the yuan to float, if not to stop angering China's trading partners, then to rebalance the economy away from exports and toward consumption.
Yet they have not done so, even though the prosperous times earlier this decade would have permitted this necessary -- and vital -- transition to occur as smoothly as possible. Now, in an especially uncertain period, a currency adjustment will be more painful. Even if it's just a small one.
Especially a small one
Why? One currency adjustment will inevitably lead to others. A small change in the value of the yuan will not have much effect on China's trade balance, so other nations will continue to pressure Beijing to allow further appreciation. Having made the first concession, Beijing then can no longer rely on the principle that it maintains a "stable" exchange rate.
The first concession also creates a one-way bet for speculators, who will naturally anticipate further revaluations. They will, undoubtedly, transfer money into China and convert it into the yuan to profit from what they will perceive to be a no-lose wager on the direction of the currency.
The new "hot money" will inevitably find its way into the stock markets, fueling a new sharp rise in values. China's currency wall -- the yuan is not convertible on the capital account -- should prevent speculative money transfers, but Beijing's own numbers show that it in fact does not.
Big trouble for Beijing
The one thing Chinese leaders do not need at the moment is fast-flowing foreign money complicating their already difficult bubble-management efforts. These days, Beijing issues consumer price index numbers showing inflation as under control -- the CPI was up only 2.2% last quarter according to official pronouncements -- but there's a good possibility that Chinese statisticians are fibbing. Even official media have expressed skepticism about the central government's inflation numbers.
So look for trouble in the Chinese economy soon, perhaps just around the time of the Toronto G-20. A small adjustment of the yuan -- as Hu Jintao foreshadowed this month -- will ultimately spell big trouble for Beijing.