Beijing’s RMB bind

By Nicholas Consonery

Over the weekend, while in Busan, Korea, U.S. Treasury Secretary Tim Geithner said Beijing should resume "reform of their exchange rate mechanism." This brief comment was just a hint at the deluge of pressure China will face from the U.S. over currency policy in coming months unless the Chinese leadership allows the RMB to start appreciating against the dollar. But these days, Beijing looks less and less willing to alter course.

The RMB has been fixed against the dollar since the beginning of the financial crisis in July 2008. A month ago, Beijing looked like it was on the cusp of revaluing the RMB and allowing more upward momentum against the dollar — mostly to assuage tension over currency policy with the United States.

But the debt crisis in Europe is weakening support in the Chinese government for changes in currency policy because the value of the RMB has been anything but stagnant against the euro in recent weeks. As concerns about European fiscal solvency have stewed in the markets, the dollar has appreciated significantly against the euro and other major currencies – and dragged the RMB along with it. Since January of this year, the RMB has actually appreciated by 20 percent against the euro-upward momentum that has accelerated significantly since May when concerns about solvency in Greece and Portugal wreaked havoc on markets. On Friday, June 4, the RMB appreciated by 1.58 percent against the euro in just that one trading day.

This rapid upward movement in the RMB against the euro presents a major concern for the Chinese economy. Why? Because the euro zone is China’s single biggest export market, accounting for 19.7 percent of Chinese exports in 2009. In recent weeks, top officials at China’s commerce ministry have publicly called for continued support for export-focused industries (which would include the currency peg) as the crisis in Europe plays out. Believers in this argument are now pointing to May’s decline in China’s purchasing manufacturer’s index, which measures industrial activity, as early proof that Europe’s troubles are already bleeding over into Chinese growth. Meanwhile, Chinese exporters and the local governments that support them report weaker confidence in the prospects for euro value and for the broader European economy.

But other policymakers in Beijing seem more optimistic. Among those is Zhou Xiaochuan, the central bank governor, who argued alongside Secretary Geithner that the euro crisis’ impact on the Chinese economy "should not be very great." This may be wishful thinking, predicated on the belief that European officials can use enough fiscal alchemy to convince forex traders that the euro isn’t on a set course to parity with the dollar this year. At the same time, Zhou might be trying to signal his continued support for pressing forward with reform to the RMB exchange rate mechanism now, despite Europe’s woes.

It will fall to the top leadership in the Chinese Communist Party structure — probably President Hu and Premier Wen themselves — to settle this debate and make the final decision about what to do with the RMB. But if history is any guide, Beijing is steadfastly opposed to any kind of "shock therapy" for the Chinese economy. And a 20 percent appreciation of the RMB against the euro in just five months seems shocking enough to delay any more upward movement in the value of the Chinese currency for now.