Beijing master of the world economy

Le Monde, 15 January 2006, by Eric Le Boucher

Who will decide the level of the dollar this year? Alan Greenspan, the head of the Federal Reserve? His successor, Bern Bernanke? No. Beijing. Who will decide the future of globalization? The 148 countries members of the WTO (World Trade Organization) who must complete this year the Doha cycle? No. Beijing.

Rarely the fate of so many has rested upon the decision of so few. At the end of 2005, China became the fourth world power, measured by the volume of its GDP. But it is already the first to chart the planet monetary and commercial future.

China trade surplus broke the 100 billion dollar mark last year, compared to 32 billion dollars in 2004.  (Note that the trade surplus of Germany was $192 billions, and that of Japan $101 billions.) Chinese exports increased by 28 percent. And it should gain a further 18 percent in 2006 according to the most official National Commission for Development and Reforms. The forecasted small slowdown is explained by oil prices and by... mounting commercial disputes with other countries.

With the United States, China exchange imbalance reached 200 billion dollars. U.S. imports of products "made in China" are sixfold higher than the U.S. exports to China.  This is twice as much as the largest trade deficit ever recorded with Japan, at the beginning of the 1980s, which, then, triggered a violent Japan bashing campaign. While in Beijing last week, Max Baucus, the leader of the Democratic finance committee in U.S. Senate, warned Chinese authorities of looming protectionist decisions in Washington if they do not take action to begin reducing their commercial surpluses.

Last spring, the United States imposed trade barriers on six categories of Chinese products. It was a short call that trade barriers be put on all imports from China by the Senate. In Congress, a bipartisan bill, called Schumer-Graham, to take retaliation actions against China is ready for vote. "Even free trade advocate Republicans will have to vote for it, lest they be accused of being anti American workers", say Morgan Stanley economists. Reminder: 2006 is midterm election year in President Bush second mandate.

On July 21st 2005, Beijing decided to revalue its currency, which is pegged with fixed parity to the dollar, by 2.1%. The Bank of China explained that it would, henceforth, tie the yuan to a larger basket of currencies, without any detail. On Thursday January 5 of this year, the authority in charge of regulating exchange rates declared its intention to "optimize the structure of its reserves", sending worrisome signals that Beijing may be about to turn away from the dollar. But, this week, the Bank of China played down the importance of this statement. China seats on 800 billion dollars of reserves (in various "safe" securities, in various currencies): if it begins to sell dollars, the consequence on foreign exchange markets could be a sharp plunge of the American currency.

Behind the yuan there is all of Asia. For all the countries in that zone, to begin with Korea and Japan, trade with China became the primary factor of economic growth. They must constantly keep an eye on the evolution of the yuan/dollar exchange rate, which determines their relative competitiveness. If their currency is "too strong", their domestic jobs are threatened to leave for China.

Will the Chinese government accept to revalue again, in order to put to rest the protectionist temptations in the United States and elsewhere? According to some calculations, the yuan is at least 25 percent below its correct value. Will Beijing take the expected step this year? It will be up to it. When it wants. By  the percentage it will choose.

The consequence on globalization will be immediate. As Fred Bersten (director of the Institute for International Economics) stresses, the pursuit of liberalization of exchanges won't be possible without a correction of commercial imbalances. Otherwise, the game is too unfair. The successful conclusion of the Doha cycle depends upon the progressive reduction of commercial imbalances. This reduction can only be achieved with a profound reorganization of currencies.  In 1985, the Plaza agreements led to a readjustment of the dollar, which reduced trade disequilibriums and made possible the successful completion of the Uruguay cycle.

Today, globalization is lopsided: trade exchanges are free but, as it is in China and all over Asia, currencies are arbitrarily set by governments.  This "discretionary exchange system", laments Jacques de Larosière, former head of the IMF and, prior to that, former head of the Banque de France, is subject to monetary manipulations to achieve super competitiveness.  In the 1930s, it is the same discretionary exchange system that led to a competitive devaluations war, and to the ultimate consequence everybody knows.  If the Doha cycle fails, "it will be the first time since the 1930s that an international multilateral negotiation fails", says Fred Bergsten.  The tone is set... China is the first beneficiary from globalization, it won't take the risk to put it in jeopardy. The couple China - United-States powerfully pulls world growth, everybody benefits from it. But the imbalance of their relationship reached breaking point. The aim is to progressively revalue the yuan while avoiding a dollar plunge. The ball is in Beijing's hands.