Some of my best friends are yuan, but

Beyond Logic

I have been following, with some amusement, the statements of myriad apologists who defend the artificially cheap Chinese yuan, pegged at 8.3 to the US dollar for almost a decade.

I had documented that this undervalued peg was a major contributory cause for the East Asian currency crisis and that the East Asian devaluations occurred because: "if China would not revalue, the rest of the currencies would devalue" (Chinese Mercantilism "" Currency Wars and How the East was Lost, Developing Trends, August 1998).

Some five years later, I am not alone anymore "" others who believe that the yuan should revalue (by at least 15 to 25 per cent) include the US government (President Bush and treasury secretary Snow), the European Central Bank, President Schroeder of Germany, and even the IMF, the last named obviously circumspect and speaking in several tongues, but managing to make the point that mercantilist trade imbalances need to be corrected just as much as trade deficits.

The infantrymen defending China's peg have increased in number, and in their ability to voice outrageous arguments to support China's mercantilism (e.g. net exports to the US averaging over $ 60 billion in each year since 2000 "" this at a time when the rest of the world barely grew). They pop up at all the 'usual suspects' places.

The tendency to defend the indefensible is tragic "" the only relief is that the arguments made by these 'experts' are so comic. Here are my top 10 favourites. All of the arguments have been culled from analysis provided by international banks, economists and other associated experts.

10. Not now, darling: "While ultimately desirable, a Chinese revaluation is not appropriate now". But it will be appropriate after China is able to capture more markets, have its reserves increase to over 700 billion from over $ 400 billion today, and when it starts growing at about six times the level of US growth, rather than only the four times excess growth that it experiences today. Duh.

9. Bubble Trouble: "A yuan revaluation would cause a huge property bubble in China, destabilising the economy". The revaluation (to begin with) being talked about is 10-20 per cent, say 15 per cent. Last year, the Chinese stock market was up some 50 per cent; that of course did not destabilise the economy, but property increases of 15-25 per cent would. Duh.

8. Boys will be boys: "China will do what China will do, and they will especially not do 'it' if the US asks for 'it'. So all ye folks who ask for human rights, democracy, corporate governance etc in China, go instead and fly a kite.

Better still, why does not the US ask for China to devalue instead "" with this policy, Chinese property prices will not rise (see above), Chinese employment problem will be solved, there will be less poor there, and the Chinese will be asked to do something that they want to do anyway!

7. You get what you expect to get: "The rapid increase in China's foreign reserves appears to be due to expectation shifts rather than change in fundamentals". Investors expect the yuan to appreciate because it is so undervalued.

This expectation causes them to exchange dollars for yuan, causing reserves to gallop. But the reserve accumulation has nothing to do whatsoever with mercantilism, just bad, naughty expectations. It is these confused expectations that force Chinese manufacturers to drive most firms, in US and Sri Lanka, to go under. Duh squared.

6. Now you want to play hardball: "It is hard to see how the western nations are pressurising China to revalue, when in 1997-1998, they were pressurising it not to devalue".

But Chinese exchange rate policy brought on the currency devaluation, and with a merchandise trade surplus (rather than the large deficits experienced by the crisis-trigger country Thailand) in the $ 50 billion plus range, it would have taken a lot of straight faces to convince the world that China needed even more trade surpluses!

5. Save the world: "China will grow below potential if it were to revalue". And 4.7 billion world citizens need to grow at below potential so that China can grow at potential. Duh, Duh. The poor Chinese need to be subsidised by the world's rich in order that their growth is high enough to solve their poverty and employment problems.

This is a noble cause, but poverty rates in China are among the lowest in the developing world. Second, there are at least double the number of poor in Africa, and the rest of Asia, as in China. A mercantilist Chinese peg hurts the poor in Vietnam and Bangladesh the most, not to mention the poor in Nigeria and South Africa.

"Upon what meat do the Chinese feed that they need to be subsidised so that they can grow at potential while the rest of the world grows at significantly below potential?"

4. Suits us to a T: "China allows US interest rates to be low because of their purchase of US T-bills". This argument is almost too ridiculous to comment upon, but I have to make a top 10 list. But it is incredible how often this argument surfaces, often made by analysts with eastern names.

In a ten thousand billion dollar economy, the interest rate is determined by somebody holding an extra 100 billion a year. I had heard of marginal cost pricing, but this one gets a triple Duh award.

But let us take the argument to its logical conclusion "" if China were to revalue, its trade surplus will go down, and the slack, given a certain US demand, will be taken up by lesser mortals. These not so worthwhile people will now buy the US treasury bills and keep US interest rates low.

3. Devalue, revalue, what me worry? "Remember the East Asian financial crisis "" it was caused by a hurried recommendation of capital account convertibility. Let us not repeat the mistake "" let China get its non-performing assets in control before recommending that they revalue the currency".

Duh, how stupid of me. Don't you see the connection "" the depreciation of East Asian currencies meant that foreign loans became dearer by the extent of the depreciation. Enterprises went under because loans in US dollars could not be repaid.

So the same will happen in China. Because of a revaluation of the Chinese yuan to about 7 per dollar, dollar loans will become cheaper by about 15-20 per cent and this will make non-performing assets into performing assets. So you see...Oops.

2. Do the math: "A Bloomberg headline "" 'Dell Computers is in China not because of the currency peg, but because of cheap labour'". Obvious, isn't it "" Chinese labour would be just as cheap for a US manufacturer paying in dollars whether the yuan was at 8.3 or 6. A question for high school math students.

If the exchange rate is 8.3, then 1 million dollars is equal to 8.3 million yuan. How many dollars will you have to pay if the exchange rate became 6? Solve the problem and do not look at the answer (Shhhh "" the answer is 1 million, according to experts at a leading American firm with hefty operations in China).

1. The Ugly American: "How dare the imperialist and racist America ask the poor, exploited, non-white Chinese to revalue? It is the bad consumption habits of the US that have led the poor Chinese to work harder than the Indians and the Brazilians and the Mexicans.

The surpluses are a just reward for hard work. It is not China that should revalue, it is the US, (even if it is a reserve currency!) that should devalue". I wish I had thought of that.

ssbhalla@oxusresearch.com