Subject: Why China Is Unwilling to Revalue the Yuan - Baseline Scenario
From: "Michael Andrews" <[email-masked]>
To: "Hunter Biden" <[email-masked]>, "Eric Schwerin" <[email-masked]>, "Devon Archer" <[email-masked]>, "Neil Callahan" <[email-masked]>, "Curt Hastings" <[email-masked]>
Date: Fri, 1 Oct 2010 09:32:02 -0400

Why China Is Unwilling to Revalue the Yuan
with 3 comments

The following guest post was contributed by Ian Lamont, an MIT Sloan  
Fellow. He was previously the managing editor of the Industry  
Standard, and has also researched China’s state-run media and  
communications policies.

For years, China has been subject to enormous external pressure to  
increase the value of its currency, or let it float on the open  
market. While doing so might relieve pressure on foreign economies by  
boosting their exports and reducing trade deficits, it runs counter to  
Beijing’s domestic priorities, which involve doing everything it can  
to preserve economic growth and domestic stability, and by extension,  
its hold on political power.

All countries exploit the dynamics between their political and  
economic systems. But China’s situation is exceptional. For three  
decades, the government of the People’s Republic of China has  
perpetuated a grand political dream, claiming a single-party political  
mandate from the Communist ideals espoused by Mao Zedong, while  
simultaneously drawing power from the capitalist canon. Beijing has  
been able to pull it off, largely through the promise of spreading  
wealth and opportunities to even the poorest of villages and  
maintaining benefits for cadres and workers in state-owned enterprises  
which cannot easily be absorbed into the capitalist system. A high  
rate of GDP growth is required year after year to maintain this state  
of affairs.

A sudden change in the value of the Yuan could have the effect of  
throwing a wrench into the works, potentially setting off a chain  
reaction of factory closures and layoffs across the interconnected  
networks that drive China’s export-oriented economy. In the short  
term, China might be able manipulate legislation, the banking sector,  
and welfare levers to prop up key industries or regions. But in the  
long term, it is uncertain if these steps would be enough to preserve  
social stability or continued loyalty to the Communist Party.

What sorts of domestic consequences would result from a slight uptick  
in the value of the Yuan? The currency is now trading at about 6.7  
renminbi to the U.S. dollar. At the very least, Chinese exports would  
become slightly more expensive to foreign buyers. The resulting drop  
in Chinese exports would put marginal factories out of business and  
put their workers on the streets. Other companies wouldshift low-wage  
manufacturing to countries such as Vietnam and Sri Lanka. In the  
industrial parks around Shenzhen, the unemployed could be reabsorbed  
into the local manufacturing economy. In remote interior provinces,  
where economic institutions are less developed, there would be fewer  
opportunities, and a corresponding rise in poverty, anti-government  
feeling, and isolated “mass incidents.”

But what would happen in the case of extreme economic disruption,  
prompted by a sharp change in the exchange rate, the currency openly  
floating on the world market, or some other unforeseen effect of a  
revaluation? The social and political turmoil unleashed by a sharp,  
sudden slowdown of the Chinese economy could potentially lead to  
Tiananmen Square-scale protests, widespread domestic instability, and  
an exodus of migrants or refugees to neighboring countries and overseas.

China is not attempting to hide its fears. “Any significant  
appreciation of the renminbi will erode China’s export competitiveness  
overnight and impact the livelihood of tens of millions of  
workers,”notes an editorial authored by the pro-government China Daily  
and republished in China’s state-run news agency in May. The essay  
further describes two economic goals: To maintain a target GDP growth  
of 8 percent per year (a level it has achieved nearly every year for  
the past two decades) and contain China’s consumer price index (which  
it tries to keep under 3%).

Additional factors may influence China’s currency policy in the short  
term. One concern is foreign policy, such as relations with key  
trading partners. Another is nationalist sentiment, which the  
Communist government has manipulated to support its own hold on power.  
Economic injustices inflicted by foreign powers on China in the 19th  
and early 20th centuries — such as the treaty ports system — still  
play a role in China’s nationalist propaganda. These humiliations  
require the current generation of Chinese leaders to tread carefully  
around policy changes that could be viewed as kowtowing to foreign  
demands.

So, for foreign governments, companies, and labor groups expecting  
China to allow its currency to appreciate, there may be no significant  
movement until China’s back is truly against the wall — or the  
leadership in Beijing can find a face-saving way to convincingly  
portray a revaluation as an advance demanded by its people, as opposed  
to a policy shift dictated by foreigners. In addition, China’s trading  
partners need to be aware that a change in the value of the Yuan will  
not by itself erase their trade deficits or reduce their dependence on  
cheap manufactured goods from abroad. Such a shift may even lead to  
problems that have long-lasting implications for China’s people and  
the global economy.