China should push international ties, focus on domestic priorities amid Trump uncertainty

By Yu Yongding Source:Global Times Published: 2017/2/6 18:03:39

Illustration: Peter C. Espina/GT

Illustration: Peter C. Espina/GT

Trump's rhetoric during his campaign showed that he would seek to reverse the US' policy toward China based on the 1972 Nixon-Mao Accord. Recent tough talk by Rex Tillerson, now the new US secretary of state, and White House spokesman Sean Spicer signals a more hawkish and unprofessional approach to the territorial disputes in the South China Sea. One has to admit sadly that if the new administration carries though with its threats and pushes China into a corner, anything can happen between Washington and Beijing. China will never bow down to Trump administration's bullying nor will it seek a military clash with the US. How to mitigate the risk of a confrontation with dire consequences while protecting its fundamental interests is indeed a daunting challenge for the Chinese government.

Compared with military confrontation, a trade war between China and the US is perhaps a more real and imminent threat. While no one knows whether US President Donald Trump really wishes to provoke a military clash with China in the South China Sea, it is certain that in order to fulfill his campaign promises Trump will implement protectionist measures while in office. Imposing a 45 percent import tax on Chinese products - as Trump previously suggested - would mean that many US imports will become 45 percent more expensive for the American working class. This is certainly a stupid policy. But how can you prevent politicians from being stupid? Certainly, China's exports will be affected. But it is hard to say who will be the bigger loser in this trade war.  

It is very likely that a trade war will first take the form of a currency war. Trump has claimed that the worst of China's sins is the wanton manipulation of its currency, which has robbed Americans of billions of dollars of capital and millions of jobs. Anyone with basic training in economics knows that this accusation is complete garbage.

Whether China resisted upward pressures on its currency by artificially keeping the yuan's exchange rate weak from 2003 to 2014 is a matter for debate. However, as pointed out by C. Fred Bergsten, senior fellow and director emeritus of the Peterson Institute for International Economics, in an article on the institute's website in November, "China has experienced large outflows of private capital that have driven its exchange rate down and indeed sparked market fears of disorderly renminbi devaluations."

"[T]he Chinese have intervened heavily on the opposite side of the market: Instead of buying dollars to keep the renminbi weak, they have sold large amounts of dollars to prevent it from sliding further," according to Bergsten.

Over the past two years, China has spent $1 trillion of its hard-earned foreign exchange reserves to prop up the yuan. This is an astronomical sum, larger than the total resources of the IMF ($660 billion) and all the money spent during the Asian Financial Crisis ($350 billion). 

Trump vowed during the campaign to instruct his Treasury secretary to label China as a currency manipulator on his first day in office. Two weeks have passed since he took office, will Trump go back on his promise to label China "a currency manipulator?" 

He may have realized that the designation of China as a manipulator is not only absurd, but also a bad tactic. As soon as he designates China a "currency manipulator," the People's Bank of China (PBC), China's central bank, can respond immediately by leaving the foreign exchange market entirely, and let the market decide at what level the yuan should be. Indeed, why should China continue to promote US competitiveness at its own expense without getting anything in return? The US Federal Reserve's exit from quantitative easing will lead to a stronger dollar, but Trump will probably hope for a weaker dollar to bolster US exports. From the point of view of the US, the only way to weaken the dollar while interest rates in the US are rising is to force other countries to appreciate their currencies. China has no intention of devaluing the yuan for trade purposes, but it also has no intention of bowing to US pressure to appreciate the yuan artificially. The only solution lies in concerted action in the foreign exchange market by major trading nations. A new Plaza Accord may be necessary.

To run a large trade surplus against the US is not in China's interest in the long run. China has been trying its best to make its growth more domestic and consumption-led over the years.

Therefore, there are common interests between China and the US to make bilateral trade more balanced. A trade war is entirely unnecessary and pointless.

Besides the Trump factor, China should also be alert to the impact of US monetary and fiscal policies. It is widely expected that to contain inflation and assets bubbles, the US Federal Reserve will raise the federal funds rate three times in 2017. While the Federal funds rate (overnight lending rate) will rise, the yield on long-term US Treasury bonds may rise even more. A steeper yield curve will affect global asset allocation. The impacts of those increases in the interest rates can be significant. There have been several important US rate hikes since the 1980s and each led to a crisis that turned back the clock on progress made by emerging market economies for many years. The latest rate hike cycle, which began at the end of 2015, is only at the beginning. Its impact on the world and China is yet to be seen.

Despite all the uncertainties, the global economy in 2017 is likely to continue to improve. The US economy will grow at a rate of more than 2 percent, and growth in emerging market economies is also expected to pick up in 2017. The best news from the US is the decision by the Trump administration to introduce a large fiscal stimulus package consisting of lower tax rates on corporate profits, and massive public investment in infrastructures. There is no doubt that a strong recovery in the US economy will have positive effects on China's exports. Nevertheless, an expansionary fiscal policy tends to worsen the US' current account, which in turn may lead to more protectionist policies with negative impacts on trade and growth.

After decades of unstoppable advances, globalization has entered a critical juncture. While there is no doubt that globalization has promoted growth and created more wealth for the world as a whole, it has failed to distribute the benefits fairly among the majority of the world's population. As a result, there is now a backlash against globalization and a political shift toward populism worldwide. Faced with a changing global environment, while persisting with reforms and opening-up, China should adjust its strategy to accommodate the changes. On the one hand, China should continue to pursue free trade agreements (FTA) and the Regional Comprehensive Economic Partnership (RCEP), and play a bigger role in promoting multilateral trade agreements within the framework of the WTO. It should also continue to pursue the reform of the international monetary system under the IMF and various forms of regional financial cooperation. On the other hand, China must be realistic and recognize its limits as one of the leading players of globalization. Instead of rushing to lead in various fields internationally, China should focus more on domestic priorities and continue to optimize its trade structure and upgrade its industries.

On the domestic front, one of the biggest challenges is the mounting pressure of yuan depreciation from persistent capital outflows. To prevent the yuan from falling, China has no choice but to strengthen capital controls. While necessary, the side effects of these controls are obvious. For example, with tight capital controls, the drive to internationalize the yuan will be hindered, and the "One Belt, One Road" initiative may also suffer.

The PBC has been striving to achieve several conflicting goals: stabilizing the exchange rate, preserving foreign reserves, maintaining an independent monetary policy and honoring its international commitments on free flows of funds under the current and capital accounts. However, it is impossible to achieve these four goals at the same time. Something has to be given up.

For example, if China wishes to achieve the goals of a stable exchange rate, preservation of foreign reserves and independence of monetary policy, it may have to tighten capital controls to such an extent that it has to go back on many of its commitments to residents and nonresidents on cross-border capital flows. This will cause irretrievable damage to its international credibility.

Though fundamentally the yuan should not be a weak currency due to the nation's large current account surplus, the devaluation pressure on the yuan will not disappear easily. Even with the world's largest foreign exchange reserves, China can't afford to continue its one-way intervention in the foreign exchange market for years - let alone the fact that persistent one-way intervention is a huge waste. In my view, the least important goal of the four is the stability of the yuan exchange rate.

Many in China are worried that if the PBC lets go of the yuan's exchange rate, a vicious cycle of devaluation will spin out of control. This is highly unlikely. Is there any precedent in economic history that a country with the largest trade surplus and fastest growth rate in the world has seen its currency fall excessively and persistently? Not to mention the fact that China still has the world's largest foreign exchange reserves and a strong ability to implement capital controls.

If the PBC stops intervention, the yuan will fall. But due to its strong fundamentals, the fall will be limited and after a relatively short period, the currency will rebound in line with its fundamentals. If the PBC fears that further depreciation could lead to a financial crisis, it could set a secret bottom line. If the PBC feels that the devaluation has surpassed the bottom line, it can step in and stop a further devaluation easily.

In short, 2017 will be a year of uncertainty and challenges. However, China will be able to face these challenges with full confidence.

The author is an academician and senior fellow of the Chinese Academy of Social Sciences and a former president of the China Society of World Economics.


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