Commentary: The G-7 holds its tongue in deference to China - Print Version - International Herald Tribune

Commentary: The G-7 holds its tongue in deference to China
By Andy Mukherjee Bloomberg News
TUESDAY, DECEMBER 6, 2005


Three months ago, finance ministers from the Group of 7 wealthy industrialized nations were optimistic that China's new currency regime would help the global economy recover its balance. Last weekend, they weren't so sure.

Consider the following two G-7 statements:

"We expect the development of this more market-oriented system to improve the functioning and stability of the global economy and the international monetary system." (Washington, Sept. 23, 2005)

"We expect that further flexible implementation of China's currency system would improve the functioning and stability of the global economy and the international monetary system." (London, Dec. 3, 2005)

Notice how the G-7's London declaration has dispensed with the confidence the ministers expressed in Washington in "this more market-oriented system."

Notice also that the ministers, having lost their early enthusiasm for the yuan's move in July to a "basket peg," have coined a rather gauche phrase - "further flexible implementation of China's currency system" - to exhort authorities in Beijing to do more.


The expression "flexible implementation" is more than just awkward; it's misdirected. It seems to suggest that the G-7 is happy with China setting the timetable for greater variability in its exchange rate. Just the opposite is true.


Rather than allowing Beijing the luxury of setting its own pace, what the group of industrial nations wants is for the yuan to trade more flexibly - from tomorrow morning if possible.

The thinking is that when the U.S. economy and currency come under strain next year, as some economists expect them to, China should do its bit for readjustment of the global current-account imbalance. That would mark a shift from the previous episode of dollar weakness between 2002 and 2004, when Europe - and to a lesser extent Japan - bore the pain of stronger currencies. The yuan followed the dollar down in that period.

The G-7 now understands that the adoption of the so-called basket peg was a political gesture, not a policy change.

As economists like Jonathan Anderson at UBS have said for some time, the yuan is still being managed bilaterally against the dollar.

From July 22, when it was revalued at 8.11 to the dollar, the yuan has tightly hugged the U.S. currency, just what you would expect from "a re-peg wrapped in lots of rhetoric about flexibility," as the Oxford University economist Brad Setser terms China's new currency regime.

A stronger yuan may contain the surge in China's trade surplus, which jumped sevenfold to $80 billion in the first 10 months of 2005. That will curb the world economy's overdependence on U.S. consumption funded by Chinese savings.


One reason the G-7 statement came out all muddled is that the ministers were walking a tightrope.


The U.S. Treasury secretary, John Snow, and his colleagues knew that their London statement was their most explicit appeal yet for change in the Chinese currency policy since they first started making broad hints on the subject at their meeting in Dubai in 2003.

Since the substance of their message is substantially provocative, they could not allow the tone of their statement to be offensive. That would only anger China and delay any currency moves that might already be in the works in Beijing.

The Group of 7's latest language, says Sabrina Jacobs, a currency strategist at Dresdner Kleinwort Wasserstein in Singapore, "is mild, not pushy, combining modest pressure with politeness, suggesting that the major developed nations have finally acknowledged that adopting a more cordial stance toward the Middle Kingdom promises a higher rate of success."


Unless the authorities in Beijing make another currency move by March, there will be pressure on the Bush administration from Senators Charles Schumer and Lindsey Graham to impose punitive tariffs of 27.5 percent on U.S. imports from China.


Battling diplomatic pressures is only half of China's job. It also needs to damp the market's expectations of a stronger yuan before the continued deluge of capital inflows into China makes that a self-fulfilling prophecy.

Anderson, the UBS economist, said that Chinese efforts to quell speculation were evident in the People's Bank of China's recent currency swap, in which the central bank agreed to sell $6 billion worth of yuan in 12 months to domestic lenders at an implied one-year appreciation of 3 percent to the dollar.

As the contours of that deal became known, the nondeliverable forward market, which was expecting the yuan to be stronger than 7.85 in one year, was forced to shed some of its enthusiasm.

There is every reason to expect that China will aim to hold on to the dollar as tightly as it can in 2006, even as the United States - and the G-7 - try their best to break the embrace.

After the G-7's clumsy statement, one wonders if China may not have an upper hand in the contest.