The U.S.-China Currency and Trade Collision Course

Posted by Nouriel Roubini - Roubini Global Economics

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Dr. Roubini reflects on recent discussions with Chinese policymakers at the China Development Forum, including his suggested response to the flaring U.S.-China currency rift, as well as in-depth discussion of what might happen if the U.S. brands China a “currency manipulator.” Below is his outline of the problem.

In mid-April the U.S. Treasury is expected to publish its biannual report on currency arrangements of other countries. There is a higher probability than ever before that China will be branded a “currency manipulator.” There is no doubt that China is manipulating its currency: After re-pegging to the U.S. dollar in the summer of 2008 and accumulating about US$400 billion dollar a year of additional FX reserves (which now stand, in total, near US$2.4 trillion), there is no doubt, from an economic standpoint, that manipulation is taking place. It looks like a duck and acts like a duck—it is clearly a Peking duck.

But every year, the United States bases the decision of whether to label China a currency manipulator more on politics than on economic facts. Until recently, the likes of Treasury Secretary Tim Geithner and National Economic Council Director Larry Summers could make the argument that a determination of “currency manipulation” for China would cost more in heightened tensions than it would net in trade gains. Such a move could start a trade war and force Chinese officials—who do not ever want to be seen as bowing to foreign pressure—to clam up even further on the currency issue and stubbornly maintain the peg to save face.

This year, several factors have increased the likelihood that China will be branded a currency manipulator. First, the U.S. unemployment rate is at almost 10%, and 17% if you include underemployed and discouraged workers. Second, three quarters of the China trade surplus is with the United States. Third, China re-pegged about 20 months ago and shows no signs of wanting to change its currency policy. Fourth, the political pressure from Congress to get tough on China is at an all-time high: A bipartisan group of 130 representatives have signed a letter arguing that it is time to label China a currency manipulator. Meanwhile, the number of protectionist bills against China in Congress is rising. Fifth, in spite of sharply rising unemployment during the recession, the U.S. refrained from taking sharp protectionist actions. The only clear and explicit case of such protectionism was the case against imports of Chinese tires, a fairly minor trade action given the severity of the U.S. recession. In the U.S. view, China abused this restraint by maintaining the peg and increasing its global trade market share, violating the open-trading system and the WTO regime by not showing flexibility on the currency issue to attempt to rectify the trade imbalances.

The sixth and most important reason China is more likely than ever to get the manipulator stamp: The U.S. administration feels that the policy of keeping quiet on China and engaging its leaders privately has failed. The U.S. grudgingly accepted for a while that China was bound to re-peg in the middle of the economic and financial storm of 2008-09, as it was rapidly losing exports and experiencing a sharp growth slowdown. In fact, had China not pegged, the RMB might have depreciated. But by late 2009, China’s aggressive policy actions had led to a rapid resumption of economic and export growth and rising inflationary pressures that could have been contained in part via currency appreciation. Thus, one would have expected China to start—or at least start signaling—the resumption of slow appreciation of the RMB. Instead, when Barack Obama went to China late last year he was effectively told to take a hike on the currency issue. He was ridiculed by the Chinese for the U.S. fiscal and current account deficits, as well as the accumulation of public and foreign debt. So it was only after months of quiet diplomacy failed to nudge the Chinese to move that the U.S. administration’s patience ran out, and the White House and Congress became publicly vocal on the currency issue.

Things have gotten so bad that even traditional supporters of free trade, and influential thinkers like economist Paul Krugman and fellows at the Peterson Institute for International Economics, are now arguing that it is time to get tough on China with an explicit threat of trade sanctions.

Editor’s Note: The full analysis, “The U.S.-China Currency and Trade Collision Course,” is available exclusively to clients of Roubini Global Economics. For information about becoming an RGE client, visit us at