China's rigid stance to not appreciate its currency continues to cause problems with "hot money" and foreign trade relations.
A report from Yi Gang, China's director of the State Administration of Foreign Exchange (SAFE), today (Tuesday) shrugged off calls for currency appreciation. Yi said China's foreign-exchange reserves – which are the largest in the world at $2.4 trillion – are safe and stable, and the country will strengthen its supervision of speculative cash inflows.
Speculation that China's currency, the yuan, is soon to rise has increased investment, but such speculation is not particularly welcome. "Underground money shops" disguise funds as foreign direct investments and trade accounts in an attempt to profit from the increasing spread on interest and exchange rates, according to Yi.
These type of investments have left a trail of "hot money" leading into China, and it may be too late to fix it.
"You can't win," Stephen Green, head of China research at Standard Chartered Bank Plc in Shanghai, told Bloomberg. "You have speculative inflows now because people expect appreciation and you will have speculative inflows if you gradually appreciate the currency. Speculative inflows are the price you pay for having waited so long to allow the yuan to appreciate."
China's refusal to loosen currency policy has continued to anger U.S. manufacturers who say increasing the yuan's value could strengthen the U.S. export industry and create employment opportunities.
In February, 15 U.S. Senators asked U.S. Commerce Secretary Gary Locke to consider action against Chinese imports, estimating China's currency is undervalued by about 40%. The senators pledged support for U.S. coated-paper-product companies who brought cases to the Commerce Department claiming China's currency policy acts as a subsidy. The paper companies requested the Commerce Department include an estimate of currency undervaluation when imposing countervailing duties on Chinese imports.
"There can be no doubt that China's policy of large-scale intervention in the exchange markets and the significant undervaluation of its currency acts as a subsidy to Chinese exports," the senators said in a letter. "As senators from key paper product-producing states, we are very concerned that domestic paper manufacturers and paper industry workers are substantially harmed by subsidized Chinese imports."
U.S. President Barack Obama has promised to get tougher on China's currency policy, but has been hesitant to attack it with too much force fearing a further strain on the countries' relations. The White House instead may choose to address the issue in the Treasury Department's semi-annual report due April 15.
Pressuring China about currency valuation has been an issue for years. The yuan peg, like China's $586 billion stimulus package, helped keep the economy afloat by preventing export disruption during the financial crisis. China is sticking by its stance that the economy is not ready for a currency raise.
"The direction of yuan reform will be gradual and controlled," Commerce Minister Chen Deming said on Monday. "If external demand has not recovered yet, how can we have a fundamental recovery? No country can have a recovery on its own."
The Chinese in mid-2008 adopted an unofficial policy to peg the yuan to the U.S. dollar. Now that the world financial markets are recovering and other countries' currencies are stabilizing, eyes are on China to adjust as well.
The IMF called the yuan "substantially undervalued" in a March 1 note to Group of 20 (G20) finance ministers and central bank governors .
"Currency appreciation is being resisted in some emerging economies and while this may be appropriate in some cases, it contributes to delaying the normalization of monetary policy and complicates global rebalancing in others," the IMF said.
The current yuan-dollar exchange rate is 6.83-1. The spread between China's one-year yuan deposit rate and its U.S. dollar deposit equivalents has reached 1.43 percentage points.
The Chinese government ran a test of yuan appreciation affects in February, according to financial newspaper 21 st Century Business Herald, but the results did anything but encourage a currency raise: For each percentage point China raised the yuan, exporters' profit margins eroded by one percentage point. That's quite a sizeable chunk when profit margins often max out at 3-5%.
China Daily, China's English-language newspaper, continuously expresses sentiment that a change in its currency will not solve the U.S.'s problems, and the country does not plan on giving in to foreign pressure. One article blamed the U.S.'s fear of China's increasing power on its persistence in targeting the yuan. Increasing pressure might even push China in the other direction, with their government not wanting to appear as though they have conceded to others' points of view.
"It will be very difficult for Chinese authorities to justify why they are allowing the currency to appreciate now," said Citigroup economist Ken Peng in the New York Times. "Appreciation is still viewed as some sort of a concession."
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