Undervalued Renminbi: Illegal or Inefficient?

The Chinese exchange rate has been the subject of recent complaints, but these are not new complaints. Early in 2000, Nicholas R. Lardy, the senior fellow of the Peterson Institute for International Economics, alleged that the Renminbi (Chinese currency) was undervalued by about 40% based on China’s GDP.  From 2005 to 2008, as China’s GDP increased, the value of the Renminbi increased in relation to the dollar by about 20%, from about 8.27 Renminbi to the dollar to about 6.83 Renminbi to the dollar.  However, the Chinese exchange rate has recently been a pretty hot issue again worldwide, and China is facing huge pressure, especially from the U.S to take action so that the Renminbi is properly valued.  On September, 29 2010 President Barack Obama said that “China’s currency is undervalued, resulting in a trade advantage for Chinese goods over American goods that contributes to the U.S. trade deficit.”  China subsequently responded and claimed that “China will not bend to economic pressure from U.S. lawmakers, even as it further opens its markets to the world.” 

If the Renminbi is actually undervalued, international economic analysis suggests that this may contribute to China’s current account surplus and the U.S. trade deficit.  As the world’s two largest economies, it is impossible to limit the imbalance between the two countries, and this problem has also lead to international imbalance as well. The U.S. has claimed that if Chinese authorities do not allow for its exchange rate to increase, it might delay the recovery from the Great Recession. If China increases the exchange rate by about 20% it may help to eliminate global imbalances, especially the U.S. trade deficit, and relieve the unemployment problem in the U.S. Therefore, there is a huge incentive for the U.S. to press China to increase exchange rate.  The European Union (“E.U.”), and other emerging market economies have similar incentives as well. Therefore, the U.S. tried to pressure China not only through political influence, but also through legal reasoning. However, as one of the biggest export countries in the world, China tries to keep their export goods in a highly competitive position in the international trade market and can rely on the advantages of its currency to do so.  Therefore, despite pressure from the U.S., China hopes to keep the Renminbi undervalued. Keeping exports competitive may be the main concern of Chinese authorities. 

There is no doubt that there will be some other uncertain risks if China changes its currency exchange rate.  For example, Japan did not expect the actions it took under the Plaza Accord in 1980s to lead to a Japanese economic recession.  See 张舒英(ZHANG Shuying), “广场协议后日元升值及对日本经济的影响 (The effect of Plaza Accord to Japanese exchange rate and economy”, April 2005.) However, if China insists that its “fixed” exchange rate be used regardless of the pressure from other countries, especially the U.S. and the E.U., the problem is that U.S. and E.U. may have no money to buy goods from China no matter how competitive or the cheap goods are. Since both the U.S. and the E.U. are struggling to recover from the Great Recession and their exports have difficulty competing with Chinese exports, they may not be able to find efficient measures to save their economies and to recover from the recession. However, China can “fix” its exchange rate, and eliminate the negative effect of the Great Recession to its domestic market. But, analyzing overall interests, the “undervalued” Renminbi makes China, the U.S., and the E.U. worse off, because it may restrict the U.S.’s, the E.U.’s, and even the whole world’s, recovery from the Great Recession, and may also cause Chinese exports to lose their biggest consumer and market. 

In the past, the U.S. tried to label China as a “currency manipulator” in order to bring action against China under World Trade Organization (“WTO”) rule and the International Monetary Fund to push China to increase its exchange rate.  However, there has not been sufficient evidence to prove China actually manipulated its currency until now.  This “manipulation” makes it more likely that the currency measures China is taking are a substantive violation of relevant international norms.  At the same time it should be noted that every country takes certain measures to control its own currency. 

In addition, there are also several legal issues involved. Current WTO members should comply with the obligations imposed by agreements.  Specifically, they should comply with the dispute of exchange arrangement among members found in Article XV  of the General Agreement on Tariffs and Trade (“GATT”), which requires the contracting parties to seek cooperation with the IMF.  The IMF may also pursue a coordinated policy with related jurisdiction.  What’s more is that Article XV (2)  stipulates that in all cases concerning the foreign exchange arrangement, the WTO shall consult fully with the IMF.   The WTO “shall accept all findings of statistical and other facts presented by the Fund relating to foreign exchange,” and accept “the determination of the Fund as to whether action by a contracting party in exchange matters is in accordance with the Articles of Agreement of the IMF,  or with the terms of a special exchange agreement between that contracting party and the CONTRACTING PARTIES” as well. In practice, the IMF has not worked effectively in changing China’s idea of its exchange rate or to settle the dispute. Although members have the duty to consult the opinion of the IMF if involved in exchange rate problems based on the Article XV of the GATT, the IMF has no authority to enforce its policy or decision among members. 

With regards to Article XV of the GATT,  section 4  states that “ontracting parties shall not, by exchange action, frustrate the intent of the provisions of this Agreement, nor, by trade action, the intent of the provisions of the Articles of Agreement of the International Monetary Fund.” Currently, there is no specific definition for the GATT’s use of “intent.” See Dukgeun Ahn, “Is the contemporary Chinese exchange-rate regime WTO-LEGAL?”, April 2010. However, we might infer the meaning of intent from the way it is used in the IMF agreement. Article IV of the IMF agreement interprets “intent” to mean “to assure orderly exchange arrangements and to promote a stable system of exchange rates.”  The understanding of “intent” within the spirit of the GATT is difficult to determine, as is determining which kind of actions “frustrate” the “intent” of GATT. Some may argue that China fix its currency exchange rate regardless of its real value, and to adjust it so that it is increased in relation to the value of China’s GDP, however, this may make the global economy worse. This is a typical action that frustrates the intent of GATT.  On the other side, Chinese scholars may argue that the Real Effective Exchange Rate of the Renminbi has already increased about 21.37% in past years, and the major reason why China’s current account surplus is increasing is the growth of China’s GDP, and that there is no significant link between undervalued exchange rate and the economic crisis. Although the exchange rate of the Renminbi looks like it is “fixed”, it does not frustrate the international trade market and violate GATT, since the “fixed” rate is decided by multiple factors, such as the demand of the market, the foreign exchange reserve, and domestic inflation, rather than taking economic advantages. Another important argument for China is that the IMF shall “respect the domestic social and political policies of members.”   In practice, the IMF takes a flexible attitude for exchange rate problems, generally choosing to respect national opinions. See “IMFWTO规定看人民币汇率; (analysis of Chinese exchange rate from WTO and IMF rules), available at: http://www.21gwy.com/lunwen/jryj/a/5539/185539.html  For example, with regards to the 1994 Mexico currency crisis, the 1997 Thailand currency crisis, and the 1998 Brazil financial crisis, the IMF left it to the market to adjust exchange rates to reasonable and effective rates rather than forcing nations to do so.  While, Article XV of GATT and the IMF agreement may be possible methods to challenge China’s exchange rate policy, it raise the problem of enforcement. The IMF has no enforcement tools of its own, and if “China does not comply with the recommendation by the WTO Dispute Settle Body,” the recommendation is hard to enforce “due to the technical problems of injury calculation.” 

Another accusation is that the undervalued Renminbi may violate the WTO Agreement on Subsidies and Countervailing Duties (“SCM”), since it works as an import tax and an export subsidy. Under Article 1 of the SCM, there are three elements of a violation: (1) there must be financial contribution by a government; (2) a benefit must be conferred; and (3) the subsidy must be specific. In China’s case, they may argue that it is not proper to find the undervalued Renminbi to be a direct financial contribution by a government, because generally speaking, changing exchange rate has never been looked at as a form of fiscal spending or revenue, although it may have similar function as subsidy, which can enhance the price of import goods in domestic and enhance the competitiveness of local goods. Moreover, the measures of fiscal subsidies under Article 1 of SCM do not include undervalued exchange rate. In addition, it is difficult to prove the “specific” element because even if the Renminbi is undervalued, China’s exchange rate policies do not focus on specific enterprises or industries, as all exports may get benefits from it. Lastly, they may also argue that the government does not provide a financial contribution, just governmental services, and it is normal for government to affect its exchange rate to a certain degree.  

Other U.S scholars also raise several “non-violation complaints” against China’s exchange-rate policy, however, they are also not tenable.  These “non-violation complaints” include U.S. approaches outside of international laws, such as punishing China by increasing the U.S. import tax of its products and taking the directly monetary measure of making  “direct purchases of Renminbi to counter China’s direct purchases of dollars.”  >See C. Fred Bergsten, “Correcting the Chinese Exchange Rate”, April, 2010. Nevertheless, they both have problems. First, by imposing additional tax on Chinese imports specifically and without the consent of WTO, this increases risk for the U.S because of the “non-discrimination principle”.  The second approach is also impractical because there is no well-functioning currency market in China, and there is a lack of full convertibility for it as well. Hence, it is difficult for U.S. purchases of the Renminbi to affect its exchange rate. 

However, the most effective way to change the current policy of China is to make Chinese authorities realize the necessity of valuing the Renminbi correctly. In the international trade market, regardless of all of the complicated statistics and standards, the currency exchange rate depends on supply and demand of all resources and products. In China’s case, with the development of its economy and advances in technology, China has  much more competence in manufacturing. Therefore, the demand of buying products from abroad decreases, and supply of Chinese products increases. Under this circumstance, it is imperative to adjust the value of the Renminbi against the value of the dollar. Although Chinese export companies may face a big challenge if the exchange rate increases, it may make global economies, as well as China’s overall wealth, better off. Because China has already issued too much of the Renminbi to balance its foreign exchange reserve, China faces the risk of serious domestic inflation. 

In conclusion, global economic recovery requires global cooperation.  Merely increasing the exchange rate of the Renminbi may not save the world. However, China should realize that to save the world it is necessary to change its exchange rate policy in relation to the growth of its economy, because keeping a lower rate to maintain advantages of exports, but ignore other disadvantages, is not a wise choice, even if it is not illegal within the WTO/IMF regime.