The Republican presidential candidate, Mitt Romney, has emphasised in all three debates his promise to declare China a currency manipulator on his first day in office. Even discounting the “get tough on China” bluster of the campaign season, this remark encapsulates American distance from, and denial about, changing economic realities. Would-be US leaders would do well to note that, for probably the first time since World War II, the dollar bloc in East Asia has been displaced. In its wake a currency bloc based on China’s yuan is emerging.
In the great Graham Greene novel The Quiet American, the worldly-wise English journalist muses that his economic handicap is in his competition with the idealistic but misguided American for the love of a Vietnamese woman: “Is confidence based on a rate of exchange? We used to talk of sterling qualities. Have we got to talk now about a dollar love? A dollar love had good intentions, a clear conscience, and to hell with everybody.” It seems now that we may have to talk about a yuan rather than dollar love. How so?
In new research, we find that since the global financial crisis, as the US and Europe have struggled economically, the yuan has increasingly become a reference currency (meaning emerging market exchange rates move closely with it). In fact, since June 2010 when the yuan resumed floating, the number of currencies tracking it has increased compared to the earlier period of flexibility between July 2005 and 2008. Over the same period, the number tracking the euro and the dollar declined.
East Asia is now a yuan bloc because the currencies of seven out of 10 countries in the region – including South Korea, Indonesia, Taiwan, Malaysia, Singapore, and Thailand – track the yuan more closely than the dollar. For example, since the middle of 2010, the Korean won and yuan have appreciated by similar amounts against the dollar. In contrast, only three economies in the group – Hong Kong, Vietnam and Mongolia – still have currencies that follow the dollar more closely than the yuan.
This shift stems in part from China’s rise as a trader: its share of East Asian countries’ manufacturing trade has risen from two per cent in 1991 to about 22 per cent today. Countries that sell to the growing Chinese market or are locked in supply chains centred on China see the advantages of maintaining a stable exchange rate against the yuan. They also fear being out-competed by China and Chinese currency movements, which also makes them track the dollar.
Trade is also propelling the rise of the yuan outside East Asia. For example, the currencies of India, Chile, Israel, South Africa, and Turkey all now follow the yuan closely; in some cases, including the Indian rupee more so than the dollar. India should, therefore, note that, de facto, the rupee is part of the yuan bloc. If China were to liberalise its financial and currency markets, which is essential for rebalancing its economy away from investment and exports toward consumption, the lure of the yuan would broaden and quicken.
This development has two implications. First, it is one more important marker in the shift of economic dominance away from the United States toward China, as argued in one of the authors’ recent book, Eclipse: Living in the Shadow of China’s Economic Dominance. Not only is China the world’s largest economy in purchasing-power parity terms, the world’s largest exporter, and the world’s largest net creditor (for over a decade), the yuan bloc has now displaced the dollar bloc in Asia. The symbolism and its historic significance cannot be under-estimated because East Asia, despite physical distance, has always been part of the dollar backyard.
America boosters invoke the rise and fall of Japan over the past few decades to suggest that China’s rise today will go Japan’s way, ensuring the continuation of Pax Americana. But they should note that, even during the heady days of the Japanese miracle, the yen never came close to rivalling the dollar as a reference currency even though East Asian countries traded as much with Japan then as they do with China today. But there was never anything close to a yen bloc in East Asia.
Second, and related to the above, is that this shift highlights the conflicting tugs that East Asian countries will face. The gravitational forces of economics, trade, and now currency are drawing these countries closer to China. But Chinese shenanigans in relation to politics and security have repelled these countries into America’s embrace, reflected most vividly in the latter’s pivot-to-Asia strategy. The old saying is that politics trumps in the short run but economics wins in the long run. If true, the strategy of relying on China for butter and on America for guns will be a difficult balancing act to pull off.
The message for the next US President is clear: America’s top priority should be internal economic regeneration rather than targeting China’s currency or other policies. The urgency of the message is underlined by the reality that that regeneration is a necessary but by no means sufficient condition for retaining American pre-eminence in the face of China’s rise.
The writers are, respectively, a senior fellow and a research analyst at the Peterson institute for International Economics. An earlier version of this column appeared in The Financial Times
