144A International Conflict Research Paper
One of the classes I am taking during my summer in the U.S. is a Political Science class focusing on International Conflict. The class teaches different political theories/perspectives, such as Realism, Liberalism, Critical Theory, World Systems Theory, Constructivism, Feminism, and others, and applies them to the Kosovo conflict. In addition, we had to select a current world conflict and write a research paper, Op-Ed, and Policy paper. I selected the US/China debate over China’s renminbi exchange rate.
Here is the Research Paper–it’s a long read at ten pages double-spaced, but I think it’s pretty interesting. I definitely learned a lot.
Grade Received: A-
History of China’s Economic Policy and the Renminbi’s Effect on World Economies
The relationship between China and the United States is a very complex one. As two of the most powerful economic superpowers on the planet, the two countries’ differing political and cultural ideals have in the past led to clashes. However, in the 21st century, the main conflict between China and the United States takes place in their economic dealings with one another. China and the US’s most recent disagreement is about the undervaluing of the renminbi, China’s national currency. The United States is hurt by what they claim is an artificial undervaluation of the renminbi. China holds a large amount of United States debt, so a change in the value of the renminbi not only affects production labor costs in China (important because that is one of investors’ biggest incentives to produce goods in China), but also keeps those production jobs out of America because labor is more expensive there. Additionally, since China and the United States are such powerful forces on the world market, changes between them affect other countries in the world. The United States has been putting pressure on the Chinese through the WTO to unpeg the renminbi from the dollar, allowing its value to appreciate, taking the pressure off of America. But the Chinese have said repeatedly that they are working on unpegging the renminbi, but they will not do it in response to any international political pressure; rather they will unpeg as they see fit as a response to economic changes in their own economy. Additionally, there are economists that think that the focus on the exchange rate issue is not the most important problem that needs to be addressed in order to solve the trade imbalance between China and the United States. In order to understand the Chinese response to this pressure and its effect on the world, it is necessary to review how China has handled its economy in the past.
Part I History:
After defeating the KMT and consolidating power over China, the Chinese Communist Party (CCP) began to address the process of helping the war-ravaged economy recover. In order to successfully recover economically, the CCP knew that no resource could be wasted. One of the ways that the CCP under Mao Zedong ensured this was through the policies they enacted towards capitalists in China who they deemed ‘sympathetic to the Revolution’. Instead of taking a hardliner approach with every single capitalist left in China, persecuting them and on principle for going against Communist theory, the CCP were moderate with capitalists who they recognized as supporters of the CCP. The CCP knew that by taking a moderate, gradualist approach, they could take advantage of the economic support that capitalists in China brought, while knowing that by making those capitalists patrons of the state that they eventually could indoctrinate them into the Party. The CCP allowed capitalists to develop their businesses in order to build up an economic structure strong enough to support a full-on transformation into Socialism.
For the next 30 years, China went through various social and political reforms, saw corruption and ideological conflict in the high government. Under Deng Xiaoping’s leadership from 1978 on however, China began to make the shift towards serious planned economic development. Though still plagued with inter-party splits (Deng Xiaoping was purged from the party and reinstated twice), as well as social unrest in the form of protests, Deng Xiaoping’s economic reforms are still counted as a milestone in China’s economic development. After Deng’s tour of Southern China, he realized that the CCP embracing the market economy growing in China was the only way to stay abreast of the peoples’ development and demands.
“The present world is open. One important reason for China’s backwardness after the industrial revolution in Western countries was its closed-door policy. After the founding of the People’s Republic[…]the country remained virtually closed, which created difficulties for us. The experience of the past thirty or so years has demonstrated that a closed-door policy would hinder construction and inhibit development. […] We are suggesting that we should develop rapidly, but not too rapidly because that would be unrealistic. To do this, we have to invigorate the domestic economy and open to the outside world.”
–Deng Xiaoping June 30, 1984 (Excerpt from a talk with the Japanese delegation to the 2nd session of the Council of Sino-Japanese Non-Governmental Persons)
Deng launched massive economic reforms in order to foster this growth, avoiding the unsolvable political arguments over whether or not his development reforms constituted ideological socialism or not by saying that the socialism he promoted was “socialism with Chinese characteristics.” By owning his reforms and taking full credit for them, the Chinese were able to view him as a founder, not as a modifier, which made them embrace his reforms instead of criticize. Foreign investment began to flow in, and China’s growth rate rose to roughly 9% yearly (Saich 63-83).
Although not directly related to the current economic conflict between the United States and China, the aforementioned history is relevant because it shows that even shortly after the Communist Revolution in China, the Chinese were thinking pragmatically about their economy—they were able to recognize that things like a market economy (and the few Chinese ‘capitalists’ who ascribed to such theory after the Revolution) is not an evil specter and eternal enemy, instead it is a force that can be harnessed and used to further the aims of the Communist party. Throughout the party’s existence, the leadership was able to (at varying degrees) see the distinction between a market economy and capitalism, and make a gradual shift towards adopting their own form of ‘Chinese’ mixed economy (Deng).
Under Jiang Zemin’s leadership, the CCP’s relationship with the United States oscillated back and forth between positive and strained, “with revival of frictions over Taiwan, human rights and WTO entry as well as unexpected events” like the accidental NATO bombing of the Chinese Embassy in Belgrade, the collision of a US reconnaissance plane with a Chinese fighter jet (Saich 84). These events all strained US and China relations, until after the 9/11 attacks, when US perspective of China switched from a threat to an ally on the ‘War on Terrorism’ (Saich 84).
China’s entry to the World Trade Organization has also hinged on its relationship with the US. China’s ascension into the WTO allowed for easier trade between China and other WTO members by lowering tariffs and forcing member countries to give special treatment and breaks to other WTO trade partners. This does mean, however, that China’s ability to export goods is made more subject to the whims and feelings of other WTO members, especially the USA, since the two countries are such big trade partners. “The policy of raising foreign capital through the production of export goods depends on the health of the international economy and especially the view of the US Congress, while the need for advanced foreign technology imports depends on the status of Western import controls. (Saich 326)” This is not something the Chinese, who are traditionally an isolationist culture, are very keen on.
The value of China’s currency, the renminbi, plays a crucial role in world trade. Because China has so much invested in US debt, a change in the value of the renminbi has substantial effects on the United States’ economy, and because the US and China are such large players on the world stage, a change in the value of the renminbi affects the rest of the world as well. From the mid-90’s until 2005, the renminbi was set at a fixed exchange rate to the US dollar (Gibson 11). However, due to pressure on China to let the renminbi float, “Starting in July 2005, the RMB was de-linked from the dollar and has since been under a managed float with reference to a basket of currencies. However, from July 2005 to March 2007, the RMB appreciated only about 7%. In particular, China’s global current account surplus in 2006 jumped to a record high of $184 billion, or about 9% of GDP. As a result, China’s foreign exchange reserves have reached $1.07 trillion, the largest in the world. China has also become the second-largest holder of U.S. bonds. (Geng)” By unpegging the renminbi, China had a surplus of currency which it then bought US bonds with in order to keep the economy stable.
Part II: Current Conflict Perspectives
Recently, the pressure from the US to let the renminbi float has been turned up, with “Sino-American relations seem[ing] to be verging on confrontation over the renminbi exchange rate. Since the end of last year, everyone in the American camp has been berating the renminbi as ‘undervalued’ or ‘rigged’ and urging for it to rise in value or to be made a floating currency. (Zhang Tingbin)” People in the United States think that the renminbi is undervalued by the Chinese government, and that the Chinese government does this purposely because an undervalued currency acts as both “an export subsidy and an import tariff (Nasution)”–having the currency undervalued means that domestically-manufactured goods in China that are sold as exports cost less to make and export than they would if the currency was not undervalued (export subsidy), and also means that when goods are exported from China their price is inflated, costing the purchasing country more money than it would cost if the currency wasn’t undervalued (import tariff). America asserts that China engages in this protectionist economic strategy in order to favor its domestic exports at the cost of jobs in America (Nasution). Therefore, America has been putting pressure on China to unpeg its currency from the dollar and let it appreciate again, in order to alleviate the burden that the renminbi’s current exchange rate puts on the American economy. America and other WTO countries planned on using this demand as leverage against China in the upcoming G20 summit, but China announced a few days before that it is going to allow the renminbi’s value to be influenced by the market more, although the government will still keep strict limit on just how much the value can fluctuate. This has been interpreted by proponents of the revaluation perspective as a political move on China’s part in order to shift focus away from the exchange rate issue while at the G20 summit, but China and proponents of the gradual appreciation perspective see it as a step forward. The People’s Bank of China released a statement saying, “In view of the recent economic situation and financial market developments at home and abroad, and the balance of payments (BOP) situation in China, the People´s Bank of China has decided to proceed further with reform of the RMB exchange rate regime and to enhance the RMB exchange rate flexibility[…]The stability of the RMB exchange rate has played an important role in mitigating the [financial] crisis´ impact, contributing significantly to Asian and global recovery, and demonstrating China´s efforts in promoting global rebalancing. […]The People´s Bank of China will further enable market to play a fundamental role in resource allocation, promote a more balanced BOP account, maintain the RMB exchange rate basically stable at an adaptive and equilibrium level, and achieve the macroeconomic and financial stability in China. (People’s Bank)”
Perspective 1: Immediate Revaluation of the Renminbi:
“China’s exports have been bolstered by its policy of keeping the renminbi pegged at a nearly fixed rate to the dollar. Many members of Congress and economists say that by spending several hundred billion dollars each year to hold down the value of the renminbi, China has made its exports extremely competitive in foreign markets and taken away sales from manufacturers in the United States and other countries. (Bradsher)” If China allows for small fluctuations in the renminbi value, then only small effects will be seen in the American trade deficit. Since China has been investing in its infrastructure recently, even though labor costs are rising in China, transportation and communication costs have dropped due to the infrastructure investment, so once again international companies making product in China are spending more on labor wages (Bradsher).
There are some that call for America to put pressure on China to strengthen the renminbi by upwards of 25% in the next 3-5 years (Cline). There are also many people from other countries who think that China should permanently and expediently revalue its currency. Brazil’s Finance Minister, Guido Mantega, “urged China to let the yuan appreciate more quickly in order to level the playing field for world trade. This revaluation needs to take place relatively quickly to allow the re-equilibrium to take place. Brazil continues to suffer… that pressure could be lessened if, for example, China permanently revalued its currency. (Agence France-Presse)” Many people in other countries think that China is being selfish and predatory and being unfair by not letting its currency float (BBC). They think that China should be fairer, and as such a major player on the world market with the ability to affect many other countries’ economies with the decisions it makes, should take some responsibility for their well being by re-valuing its currency instead of letting it float and gradually appreciate.
America wants the renminbi to increase in value because that will alleviate the trade deficit between America and China—if goods are more expensive to produce in China, then manufacturing jobs will flow back into the United States.
Perspective II: Steady Appreciation of the RMB:
Others think that China is right not to cede to demands for a revaluation of its currency. They are in agreement with revaluation’s assertion China needs to work on its domestic consumption, however they argue that a quick revaluation “by 20%, as certain foreigners recommend, [could result in] a sharp fall in spending on its goods, which would undermine growth.” Indeed China needs to build “a social safety net, develop its domestic financial sector, and strengthen corporate governance to encourage SOEs to pay out more of what they earn” in order to increase Chinese household spending. But such reforms take years to complete. In the meantime, the rate of spending growth in China will not change dramatically.” They argue that “because the increase in US spending on Chinese exports will be gradual, it also is appropriate for the adjustment in the renminbi-dollar exchange rate to be gradual. (Eichengreen)” The problem with this in revaluationist eyes is that the United States’ trade deficits are not getting any smaller, which is the cause for the call for revaluation in the first place.
Also, in response to American revaluationist fears that the Chinese are going to use their huge investment into American debt to dump “its $2.45 trillion stockpile of reserves, the world’s largest, [like] a ‘nuclear weapon’ (Xin, Wheatley)” in order to cripple the American economy. They fear that China wants to destroy the United States through its economy. China assures against this, that their ownership of American securities holdings is “a normal investment operation”, and is not for political gain. “The statement appeared to be an attempt to defuse concerns in the United States and elsewhere over whether Beijing might threaten to sell off Treasurys or other holdings to punish them in political disputes (Ajc.com).” China is Washington’s biggest foreign creditor, with just over $900 billion invested in Treasurys “The U.S. Treasury market is the world’s largest government bond market, and U.S. Treasury bonds deliver fair good security, liquidity and market depth with low transaction costs. The U.S. Treasury market is a very important market for China,” said SAFE, the branch of the People’s Bank of China that manages currency reserves. Additionally, SAFE pointed out that there are fears that massive American borrowing will lower the value of the dollar, and that “the United States and other major countries to take ‘responsible measures’ to maintain the value of their currencies. This meant withdrawing monetary stimulus in a reasonable manner and relying less on deficit spending. (Xin, Wheatley)“ It is not completely due to China that the trade imbalance is present. China wants to let its currency change, but it pushes a collaborative, gradual change instead of this unilateral push by the United States to revalue its currency overnight.
Perspective III: The Exchange Rate is not the Only Main Issue:
Yet others postulate that only adjusting the rates is not enough, and that low wage brought on by an artificial devaluation “is neither the single factor nor even the most important factor pushing the advance of China’s export competitiveness. (Geng)” Instead it is due to the decrease in transaction costs in China due to advances in the international supply chain. It is easy for China to export because of its cheap labor, but China’s internal problems make it hard to promote domestic growth and consumerism which would promote imports into China. The trade deficit stems from China’s internal consumer support problems (no safety net, welfare, lack of infrastructure which supports individual consumption), which are not helped by simply an increase in exchange rates (Huang). “Since the barriers to imports are primarily in the realm of hidden transactions costs, not in price, an emphasis on exchange rate adjustment would not be as effective as a focus on reducing the barriers and constraints facing imports into China. (Deng)” China needs the cooperation and patience of its trading partner countries like the USA in order to fix its internal problems so it can then work to alleviate America’s deficits. “China should be encouraged to run a stable but low rate of inflation first, say about 5% a year, so as to match the steady growth of its domestic price levels with those in more developed economies. When structural inflation, which is different from pure monetary inflation, is expected to reach beyond 5%, China should also add currency appreciation as an additional instrument to further absorb the pressure for increases in domestic price levels. This inflation-first and appreciation-second strategy would avoid the risks of both deflation and excessive inflation. (Deng)” Instead of focusing on the exchange rate as the main issue, it is the price levels in China and the lack of a strong consumer base that keeps China’s trade surplus so high, so the best way to balance trade is to help China develop its own consumer base. The problem with this is that it takes time, and the United States does not want to wait the years it will take for the proper reforms to take effect (Deng).
There are many different perspectives on the implications and methods of China’s currency value appreciation, and they are also very politicized. Perspectives differ between nationality (Americans tend to want the renminbi to be revalued regardless of the cost to China, as it would help American debt), and in terms of how cooperative China and the United States should be with one another in working through this currency issue. The economic conflict between China and the United States goes much deeper than just this disagreement over the exchange rate—in fact, the exchange rate is just the most recent snag in the development of the relationship between both countries.
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