The US Government and China’s Currency

From February 26th through the 27th I attended a symposium at the University of Texas in Austin, TX on China’s Emergence: Effects on Trade, Investment, and Regulatory Law.

Here are some thoughts on the more notable issues raised at the symposium:

Timothy Reif, the incoming General Counsel of the Office of the US Trade Representative, spoke as a private citizen to open the event as its keynote speaker. He expressed a desire for China to “stop manipulating” its currency and to move on currency reevaluation. Currently, China’s currency trades in a limited range of .5 percent daily against the dollar (up from .3 percent daily pre-2007).

Responding to a question, Reif acknowledged that China’s economy and the world’s economy would need time to adjust to a freely-floating regime. He suggested that China might not be prepared to freely float the RMB until perhaps 5-10 years in the future. Still, Reif speculated that if the Obama administration did not push China to take some actions toward reevaluating its currency, then the United States Congress may take aggressive action against China.

Reif’s speculation may be based on fears grounded on prior Senate actions directed against China’s currency valuation. (The following paragraph’s information is supplemental. The issues were alluded to, but not discussed in depth. The summary is provided for readers’ reference.)

In 2005, Senator Schumer introduced a bill in the Senate, S.295, that would impose an additional duty of 27.5 percent on “Chinese goods imported into the United States unless the President submits a certification to Congress that the People’s Republic of China (PRC) is no longer manipulating the rate of exchange and is complying with accepted market-based trading policies.” (Thomas.Loc.Gov) That bill was not put to a vote and, even if passed, would have been non-compliant with WTO standards. However, in 2006 and 2007, Schumer and others in the Senate tried again with a bill believed to be WTO-compliant. That bill was the Currency Exchange Rate Oversight Reform Act of 2007, which was placed on the Senate legislative calendar after passing the Senate Finance committee with a 20-1 vote; but the bill ultimately did not come to a floor vote.

Ultimately, Reif did not indicate support for China to take any particular policy. He expressed no opinion on support for a wider managed band in which the currency could trade, nor for increased disclosure on which currencies are included in China’s market basket. His believes it is imperative that China’s currency appreciate, but at the time and in this venue he could not comment on exactly how the appreciation should be managed.

The most interesting question raised by Reif’s talk was to what degree will US President Obama and the Congress push against China to appreciate its currency during this economic downturn that is negatively affecting both countries. His comments seem to reflect that if America’s economy fails to improve, then domestic pressure will encourage Obama and/or Congress to take significant action to counter “imbalances” caused by China’s currency policy.

(Part III will include commentary on presentations from Raj Bhala (Law Professor at the University of Kansas), and John Greenwald (International Trade Lawyer).

Consequences of China’s Oil Price Hike

China has finally raised the prices on its oil. It came a bit sooner than I expected, but as I stated in “China’s Oil Price Freeze,” the raise was a lot lower than needs to be done (China’s prices are still 1/4 cheaper than gas in the US and 1/3 cheaper per liter than oil in the UK). The United States’ prices on oil have risen over 50% since December 2007 (based on calculations of average gas prices of 2.71 in 2007, according to the EIA);

China only raised their oil prices 16 to 18%. (In November, they raised prices 11% to confront $80/barrel oil;  China’s oil companies appear to still have a shortfall of $21 dollars per barrel from current prices of nearly $130 a barrel.)

Rising oil prices will affect Chinese stability, inflation, and government openness.

STABILITY

According to Xinhua, the Chinese State news agency: “more subsidies would be offered to farmers, public transport, low-income families and taxi drivers to cushion the crunch of price rises.” According to FT, “the finance ministry said the targeted subsidies would amount to Rmb19.8bn ($2.9bn, €1.8bn, £1.5bn).”

Given  China’s huge trade surplus, the burden of cost can be arguably borne by the government (And the amount of subsidies direct to the people currently is far less than the amount of subsidies ($50 billion plus) the Chinese government would have needed to give to state oil corporations forced to do business at under-market prices. Apparently,  Sinopec was losing money on imports when “the international price exceeded $78 a barrel.”)

The problem with the Chinese government pumping a lot of money into the hands of its poor peasants, however, is that it can lead to inflation. In a similar situation in Indonesia “the [Indonesian] government forecasts inflation will rise to 12% in June — up from 8.96% in April — as the fuel-price increase feeds into the broader economy.”

INFLATION

Remember, in 1989, part of the impetus for the massive protests was runaway inflation, rising unemployment and lowering standards of living. And as Pieter Botellier of the Jamestown Foundation also argued; “the Communists’ defeat of the Nationalists in the Chinese civil war of 1945-1949 was greatly assisted by the run-away inflation of those years, which sharply reduced the popularity of Chiang Kai-shek’s Republic of China (ROC) government. ”

This is not to say China’s government is in any danger of losing its grip on power– but rising inflation might cause its leaders to look to past lessons of history and react skittishly to the consequences of unrestrained inflation. According to Prof. Victor Shih of Northwestern, this is the highest inflation we’ve seen in China since the mid 1990s. Also according to Shih, there is a current factional dispute in China’s leadership about whether to continue to tighten the monentary supply, or to reevaluate the RMB upward to correct the domestic inflation problem. It’s a complicated situation, and I recommend reading his article for more details.

OPENNESS

In light of increased tensions as a result of upwardly spiraling inflation and energy costs; President Hu Jintao might be encouraged to crack down more on free press and coverage of unrest that will likely emerge as people are able to afford less and less.

The Chinese belief has long been that silencing opposition makes it go away. We’ll see what happens over the coming months.

RESULTS

Due to transportation costs, Chinese food prices will increase even more than the 22% percent they have already appreciated since last year. (In all, according to the BBC, China’s inflation as of April was up 8.5% on the year.) Rising inflation could lead to big problems and the end of 4 kuai (.50 cent) meals that sustain many low-paid migrant workers who labor in the cities and send remittances to their farming families.

Already, there has been a slight decrease in the amount of migrant workers in China’s coastal cities (regrettably, I can’t currently find the Journal article I saw the numbers for this cited in- I will post it as soon as I find it), driving up prices for construction and leading to more inflation. The eventual return of these workers to their villages and second-tier cities might be good for the economy in the long-term as some population stress is removed; but in the short term, their return with big city views, and big city demands for quality of life, these returnees could have big cosmopolitan demands for their local governments- demands that might not be met and could cause social unrest.

IN SUMMARY:

ONE Beijing still needs to subsidize a gap of around $20 in international purchases of oil. Its importing companies are still losing cash, but ultimately China can weather slightly cheaper oil prices than the rest of the world since “average Chinese [domestic] production costs were about $US20 ($21)”. It’s the internationally-bought oil gap that China has to pay for.

TWO China also has to manage the social unrest that will originate due to the rising oil prices. Subsidies to the right populations should take a lot of the bite out of that unrest. Prof. Victor Shih of Northwestern speculates a little on what needs to be done to prop up the Chinese middle and lower classes after gas prices rise. 

THREE There may be citizen-government clashes over the increased oil prices, much as there were in March 2007 during the Yongzhou Mass Incident,  sparked over rising public transportation costs. This could be why public transport costs are being kept steady. (According to the FT, “CSFB, the investment bank, estimates that an 8 per cent increase in fares would add 2.3 percentage points to inflation. “)

FOUR If there are clashes, the government will likely clamp down, and try to keep the media from reporting on negative developments since China does not want to look bad in the year of its Olympics (as noted in my earlier article.) How successful they are remains to be determined.

FIVE And certainly, other reprecussions will be demonstrated, from migrant worker movements, to wage price increases, to possible capital flight from China. Remember, it’s China… Anything can happen.

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Also of note: An article on hidden cost of fuel subsidies explains why China needed to reevaluate its oil prices.

And Forbes discusses in more detail the weird situation where one of China’s national oil companies, Sinopec suffered under the system and required billions in state subsidies to prop up its foreign oil acquisitions.

http://www.eeo.com.cn/ens//Industry/2008/06/25/104320.html Also had an interesting article on the possible reprecussions of the price rise on China’s national oil companies.