Currency War: China Stands Firm on Yuan as Global Criticism Escalates

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Germany and Japan are joining the U.S. in pressuring Beijing to let the yuan appreciate to prevent an international currency war from spiraling out of control. Still, China remains firm that a gradual rate change is all it will allow.

German Economy Minister Rainer Bruederle warned yesterday (Wednesday) that a trade war could erupt if China didn't float its currency for a more fair value. As the China-U.S. currency tensions have heated up, other countries are saying China's unfair trade advantage is threatening export-driven recoveries around the globe.

"We have to take care that the currency war doesn't become a trade war," Bruederle told German business paper Handelsblatt. "China bears a lot of responsibility for ensuring that it doesn't come to an escalation."

China's $16.9 billion trade surplus in September narrowed from August's $20 billion level, but is still unsettlingly high for countries facing large trade deficits, like the United States.

China removed the yuan's peg to the U.S. dollar in June after mounting pressure from the United States, but has only allowed its currency to rise 2.3% since, falling far short of U.S. expectations.

Now other countries are struggling with rising currencies that threaten their economic recoveries. The euro has soared against the dollar and the yen hit a 15-year high that led Japan to intervene in its currency market last month for the first time in six years.

Japan sold an estimated $20 billion yen as the currency surged to a little short of 90 to the dollar. Some analysts and Japanese policymakers had theorized that China was attempting to hamper Japan 's recovery by purchasing Japanese bonds to keep the yen excessively strong.

Japanese Finance Minister Yoshihiko Noda recently noted that Japan has only intervened once in currency markets, while South Korea appears to be far more active.

"With regard to the won, surely repeated interventions have been made," and "progress has been slow" in regards to yuan appreciation, he said.

A weak won has favored Korean companies over Japanese competitors for years. Since September 2008, the yen has climbed 29% against the U.S. dollar while the won has weakened 1.2% against the dollar and 23% against Japan's currency.

South Korean and Chinese officials have defended their currency policies and said neither country wants to perpetuate a currency war.

"We are doing our best to avoid that but it will require the effort of all the G20 members, not China alone," Cui Tiankai, Chinese deputy foreign minister, said during a recent visit to Seoul.

China's Unwavering Stance  

So far China has reacted to international pressure by telling foreign leaders to back off the issue, and that rapid yuan appreciation would cause too much damage to the Chinese economy through factory closures, job losses and social unrest.

"Many of our exporting companies would have to close down, migrant workers would have to return to their villages," Chinese Premier Wen Jiabao warned.

China's central bank governor Zhou Xiaochuan last week said he supported a gradual rise in the yuan, but also remained firm on resisting the quick change foreign nations demand, saying "there will be no shock therapy."

The likely next step for currency resolution will be at the Group of 20 (G20) meeting next month in Seoul.

But before then U.S. Treasury Secretary Timothy F. Geithner will have another chance to formally name China as a currency manipulator, although most experts think Geithner will again skirt the label.

"Even if they do name China [as a manipulator], the only way to pursue the issue is through the G20 in any case," Steven Englander, head of foreign exchange strategy for the big economies at CitiFX, told the Financial Times.

The FT's Martin Wolf supports unity among G20 nations to encourage change in China's currency policy, but also offers little in the way of detailed maneuvers for doing so.

"[H]ow might China be cajoled or coerced into changing its policies? Negotiation remains a hope. The rest of Group of 20 leading countries should unite in calling for these changes. But if negotiation continues to fail, alternatives must be considered," said Wolf.

The U.S. House of Representatives took a route other than negotiation last month by passing legislation that would impose heavy tariffs on goods from countries with intentionally devalued currency. The proposal is now awaiting action in the Senate.

Germany's Bruederle warned that the tariffs proposed by the United States would "only lead to retaliation."

"We can all only lose through protectionist measures," he said.

But Nobel Prize winning economist Paul Krugman has said it's time for the United States to take action.

"[I]f China continues on its present course, eventually we will have some serious currency and trade conflict. Furthermore, we should," wrote Krugman.

While some economists are supporting sending a dynamic global message to China, the repercussions remain a concern. Opponents to the U.S. proposal say the United States should be careful not to anger the largest holder of U.S. government debt. If China unloaded its $846.7 billion in U.S. Treasuries, U.S. interest rates would rise.

But Krugman says the U.S. doesn't need China's money.

"It's true that the dollar would fall if China decided to dump some American holdings," said Krugman. "But this would actually help the U.S. economy, making our exports more competitive. Ask the Japanese, who want China to stop buying their bonds because those purchases are driving up the yen."

Now Japan is on its way to becoming the top holder of U.S. debt, a title it hasn't held since August 2008. Japan added $55.3 billion in Treasury bonds to its reserves this year, boosting total holdings to $821 billion. Japan could once again overtake China if it continues to intervene to hold down the value of the yen.

"It would not be a total surprise to see Japan as the No.1 holder of Treasuries by the winter," Dan Greenhaus, chief economic strategist at Miller Tabak & Co., told The Wall Street Journal.

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