China runs circles round adversaries
If the global currency war was a baseball game, they would have to invoke the “slaughter rule” and send China home the winner.
Motivations and consequences aside, China is so adroit in melding diplomacy, jawboning and action to keep the value of its currency low that you have to feel something approaching compassion for its plodding adversaries from the U.S., Europe and Japan.
China’s latest well played move is its pledge to use some of its massive foreign currency reserves to support poor Greece, which the markets widely believe will default some fine day, European Union support or not.
“With its foreign exchange reserve, China has already bought and is holding Greek bonds and will keep a positive stance in participating and buying bonds that Greece will issue,” Chinese premier Wen Jiabao said in Athens on Saturday.
“China will undertake a great effort to support euro zone countries and Greece to overcome the crisis.”
While China does have an interest in global economic stability, especially stability in currency regimes, this was not a move primarily motivated by a regard for European solidarity or even the principle that cheaters deserve a second chance.
Lombard Street Research economist Gabriel Stein nailed this in a note to clients:
“Fiscal troubles in the euro area mean a volatile and most likely weakening euro. By contrast, support from a large outside player like China is likely to strengthen the euro. But against whom will the euro strengthen? Primarily against the dollar — to which the Chinese authorities have pegged their own currency at a rate generally accepted to be considerably undervalued. (If it is not, why the strenuous opposition to yuan flotation?)”
A weak euro means that Chinese exports to the euro zone become more expensive, hence the support, which is cheap at the price, because, after all, Greece is not currently issuing bonds and talk is, the last time it traded on the exchanges, fetching absolutely nothing.
That China was not in Europe solely on a mercy mission became apparent Monday when it met calls from EU officials for a flexible yuan with counter-calls for stability in major currencies.
Stability in currency markets, which by the way is highly unlikely going forward, is good for China because it makes the task of manipulating the value of the yuan to its best advantage that much simpler.
“Hold still,” the shearer said to the lamb.
As it is in Europe, so it was in Asia, where Chinese purchases of Japanese government bonds, made in the name of “diversification” drove the yen higher, potentially undermining an already flagging economy. Japan acted in response by buying dollars to drive down the yen, in effect doing China’s currency manipulation for it. China gets a more diversified portfolio, insurance against any fall in Treasuries, and still gets its near-term goal of a continued strong dollar and the exports and jobs that means.
As for the U.S., there seems to be no consensus, at least yet, to take a hard line. The House of Representatives passed a bill that would allow the U.S. to treat undervalued currencies as an illegal subsidy and impose penalties in kind, but this may not make it through the Senate and is unlikely to be signed by the President if it does.
There are two points to be made in China’s defense. First, the stakes for it are arguably higher, its people being poorer and its social welfare net thin. While high unemployment and deep benefit cuts may result in strikes or airport delays in Europe, the equivalent in China could be far more destabilizing.
Secondly, China is like anyone who, having enjoyed a good thing, finds lots of competition arising: unhappy. China for years kept its currency low and its exports high, but now that the bill has come due everyone else wants to get in on the game.
The International Monetary Fund, in its World Economic Outlook, touches on this:
“Because not all countries can have real depreciations and increase their net exports at the same time, simultaneous fiscal consolidation by many countries is likely to be particularly costly.”
No one, at this point, seems to have both the courage and the political will to stimulate when all around them are consolidating, and that means that everyone, almost literally, is going to be trying to export, and is increasingly likely to try to manipulate their currencies to support that effort.
Smaller nations, such as Brazil and South Korea, are either already doing it or making threats.
China’s very success and skill bring with it risks: that its main adversaries are ultimately goaded into taking more extreme and unpredictable action in their frustration and failure.