Playing the Cards Right, or Playing the Right Cards: Foreign Political Pressure and China’s Currency Policyby Kent Troutman | February 24th, 2014 | 05:06 pm
On February 14, 2014 the second season of the popular political drama House of Cards debuted and to the surprise of many, the diplomatic relationship between the US and China took on a significant role. In the show, a powerful Chinese princeling and an American energy tycoon team up to influence US policy in ways that will benefit their respective commercial (and political) interests. The major economic issue of contention was how the US should approach the perennial concern of currency manipulation by China. At one point, the Chinese tycoon states that because of particular internal political dynamics, the most effective way to get policymakers to allow the currency to appreciate was to have the United States pressure China. Otherwise, certain entrenched interests have no impetus to reform.
Aside from being a thumping good show, this interplay has roots in the real dilemma facing certain advocates of reform – both domestic and foreign – within China. This post will briefly explore whether foreign pressure is effective in influencing China to allow the RMB to appreciate.
There is considerable debate about whether foreign political pressure affects the currency policy. Statistically, a 2008 paper by the HKMA finds that there is no evidence that foreign pressure affects the pace of appreciation, but with some limited effects on the volatility thereof. Others analysts and commenters often assert, however, that China does indeed allow the renminbi to appreciate ahead of important bilateral diplomatic meetings with the US, in order to weaken the US’s leverage, which is an implicit indication of foreign influence. As shown below, this does seem to be present in the past during the Bush-era, but has diminished recently (exhibit 1).
Exhibit 1: Renminbi appreciation prior to major bilateral meetings with the United States*
Source: FREDdata, US Treasury, author’s calculations
* This includes the predecessor to the Obama administration’s S&ED
From a political economy perspective, Gary Hufbauer in Debating China’s Exchange Rate claims that pressure in the form of unilateral countervailing legislation from the US Congress is unlikely to persuade the powerful domestic interests to speed appreciation. But Hufbauer does concede that a multilateral approach could be more successful. One issue with the multilateral approach is that, unsurprisingly, the most effective and viable partners in such multilateral efforts often have direct or indirect interests that run counter to the US’s and thus are unwilling to cooperate. Indeed, unlike trade and some regulatory spaces, the gains from monetary cooperation are negligible since governments each pursuing their national interests, should allow private markets to arbitrage away any welfare losses (for more on the literature of monetary cooperation, see Broz & Frieden 2011). This supports the idea that the primary drivers of currency policy are the interplay between Chinese domestic interests, not pressures from foreign governments.
So what is the current state of the currency reform discussion? In a recent statement, the PBoC state that it would widen the daily trading band this year in an ‘orderly fashion’. This would certainly be a positive development, although the PBoC reserves the ability to set the fixing rate (the rate around which trading happening in a day) at any level they’d like. More will have to be done, however. Although the renminbi has appreciated by over 3% against the dollar since 2012, after a record-setting year of reserve accumulation (i.e. currency intervention) in 2013, it seems clear that there continues to be pressure and scope for further appreciation.
Exhibit 2: Renminbi level and deviation from fixing rate
Like all reform efforts, however, the expansive reform program currently being undertaken by the Xi/Li government will not be without its losers. Very large and entrenched interests, largely in the financial and manufacturing sectors, that would be adversely affected by many of the reforms stand opposed to proposed marketization of the currency and general liberalization of the financial sector. Indeed, certain government ministries are more dependent on the financial and industrial sectors for revenues and political support than others, and thus generally oppose reforms. Additionally, there are many individuals within the government apparatus that benefit personally from the status quo.
Often, as witnessed in US and in parts of Europe over the past five years, it takes a crisis (of varying proportions) to uproot these entrenched interests and move ahead with reforms. In the case of China, such crises have, at alternating times and intensities, taken the form of concerns and minor crises in shadow banking, real estate, and a growing worry, the tremendous size of and welfare losses due to the build-up of reserves. While it is clear that the broad objectives of reform have support at the highest levels, implementation has been slow and inconsistent. This underscores the difficulty of taking on interests and institutions that have developed for more than three decades since the market reforms in the early 1980’s. Specifically on currency policy, reformers in Zhongnanhai will need to emphasize costs of continued intervention and push to allow the currency to float more freely, because that is where the decision will be made and consequences countenanced, not in Washington, Brussels, or Tokyo.