Should Europe join the US in condemning Chinese currency manipulation?

Patrick Messerlin 16 April 2010

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The debate on China as a currency manipulator is showing illuminating twists in Washington.

  • First, a very strong campaign echoed by an opinion column by Nobel Prize winner Paul Krugman.
  • Second, the unexpected delay of the release of the US Treasury report that could brand China as a “currency manipulator”.
  • Finally, the announcement of the slide of China’s trade balance into a deficit in March 2010 (for the first time since 2004) a few days before President Hu Jintao will attend a nuclear security meeting in Washington.

All this underscores, if needed, how much the debate has shifted from economics to politics.

The situation is quite different in Brussels. There is no sign of revival of the EU-China skirmishes of late 2007 and early 2008. In mid-October 2007, following the confrontational tone adopted by then EC Trade Commissioner Peter Mandelson, the European Commissioner for Economic Affairs breached for the first time the official EU silence on the appropriate exchange rate of the Chinese renminbi, unleashing a batch of statements from Eurozone Finance Ministers and the European Central Bank President urging China to let the renminbi appreciate against other global currencies.

Since late 2008, European policymakers have been much less vocal. Such a quiet approach could simply mirror ongoing exchange rate variation. The fact that China pegged the renminbi to the dollar since July 2008 means that the euro-renminbi exchange rate echoed the depreciation of the euro with respect to the dollar. After ups and downs, the euro is now back to its early 2007 value in dollar terms – a 15%depreciation vis-à-vis the renminbi.

Beyond these recent currencies' evolution, several strong and mutually reinforcing economic and political reasons may induce EU officials to retain their current low-key line on these matters. In which case, this will be in the interests of the world economy, not just the EU.

Starting with economics…

First is the simple fact that predicting the “right” exchange rate is an impossible mission. During recent years, economists have disagreed markedly on the magnitude of the renminbi undervaluation – from zero to nearly 50%, largely for reasons related to assumptions, variables included or otherwise in empirical analysis, etc. These technical differences have been carefully documented in IMF studies (Dunaway and Li 2005, Dunaway et al. 2006). Other studies suggest that, if there were an “undervalued” Asian currency against the dollar, it would be the Japanese yen, and that the euro would be “overvalued” against the dollar by 5% to 35% (all these estimates were made before the late-2007 to mid-2008 slide of the dollar).

Second, the focus on trade balances has had relatively little appeal in the EU in the recent years. The EU has a relatively modest trade deficit with respect to the world. More importantly, while China’s share in the EU's total imports (excluding the EU-OPEC trade) has doubled (from 8% in 2000 to 18% in 2008), the share of nine other large trading partners of the EU (Japan, Korea, Hong Kong, Indonesia, Malaysia, Singapore, Taiwan, Thailand, and the US) has decreased to such an extent that the global share of China and these nine countries has decreased from 55% to 46%. This result underscores the massive reshuffling of trade flows among key EU trading partners. Products that were previously shipped from those trading partners are now imported directly from China. In short, the only difference between today and the mid-1990s is that the EU global trade deficit is not spread over several Asian countries but concentrated with one of them – hardly a source of deep concern.

Finally, to be credible, an EU line about currency changes should be consistent with the EU's internal economic situation. Out of the fifteen Eurozone members, nine have run a trade deficit more or less continually since 1995 and five almost always a trade surplus (only Italy has significantly shifted from a trade surplus to a trade deficit during the period). In addition, almost all the EU member states having a trade deficit with the other EU member states exhibit intra-EU trade deficits that are (much) larger than their trade deficits with China (Messerlin and Wang 2008).

This last economic reason is already striking strong political chords, one external, one internal. First, the EU could hardly be seen by China as consistent – hence convincing – when complaining about China’s persistent trade surplus, while the largest EU economy, Germany, shares the same feature with the rest of the Eurozone and of the world. Second, a chorus of complaints about China’s permanent trade surplus was doomed to induce, sooner or later, some EU politicians to use the same litany against Germany. Mid-March 2010, this Rubicon was crossed by the French Minister of Economy, Christine Lagarde, who stated that the German deficit was “unsustainable”, without much explanation as to why it was sustained during the last thirty years or so. Of course, German politicians reacted swiftly, some of them beginning to evoke a core Eurozone around Germany, with Mediterranean member states clearly outside, and France somewhere in the limbo. In short, a strong battle with China on trade surplus and exchange rate is doomed to degenerate into intra-EU discord, the last thing that responsible EU leaders would like to see happening in the current circumstances.

Combining these observations generates strange bedfellows. Germany, the staunchest US ally in Europe and the largest European economy, may have some sympathy for China during this episode. This is not only because China is one of its core markets, but because it is facing the same pressures to do something about its “unsustainable” trade surplus with Europe. It is also because it was threatened by the US to be a “currency manipulator” in the early 1970s and early 1980s. These threats never materialised because Germany, often dubbed at this time as an economic giant but a political dwarf, gave up and revaluated the Mark. At that time, it was politically hard for Germany to swallow, although it ended up in various forms of commercial success that Chinese decision-makers should ruminate on.

…Ending up with politics

Internal political reasons should also induce EU officials to refrain from taking a hardline on Chinese currency changes. First is that, to the great disappointment of most Europeans, the euro is still in its making. When the euro was adopted, all the EU's non-German politicians (and all but a few economists in the EU) dismissed the high risks of such an endeavour – ignoring that any federation (the euro is a federal principle) implies risks of secession for a long time. The euro was proclaimed the heir of the Deutsche Mark, hence endorsing its long history of market-driven appreciations. Such a history has shaped the German economy, in particular its specialisation in products relatively insensitive to price increases. However, key Eurozone members (France, Italy) did not (want to) realise the extent to which they would have to transform their own economies and to reshape their domestic policies in order to adjust to the German approach.

 

 

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Topics:  Europe's nations and regions Exchange rates

Tags:  eurozone, global imbalances, China, exchange-rate policy

Professor of Economics, Sciences Po and Director of the Groupe d'Economie Mondiale de Sciences Po (GEM)

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