China's Currency Rises in the US Backyard
by Arvind Subramanian, Peterson Institute for International Economics
and Martin Kessler, Peterson Institute for International Economics
Op-ed in the Financial Times
October 21, 2012
© Financial Times
The Republican presidential candidate Mitt Romney last week repeated 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 the Second World War the dollar bloc in East Asia has been displaced. In its wake a currency bloc based on China's renminbi is emerging.
In new research, we find that since the global financial crisis, as the United States and Europe have struggled economically, the renminbi has increasingly become a reference currency (meaning emerging market exchange rates move closely with it). In fact, since June 2010 when the renminbi resumed floating, the number of currencies tracking it has increased compared with 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 renminbi bloc because the currencies of seven out of ten countries in the region—including South Korea, Indonesia, Taiwan, Malaysia, Singapore, and Thailand—track the renminbi more closely than the US dollar. For example, since the middle of 2010, the Korean won and the renminbi have appreciated by similar amounts against the dollar. Only three economies in the group—Hong Kong, Vietnam, and Mongolia—still have currencies following the dollar more closely than the renminbi.
This shift stems from China's rise as a trader; its share of East Asian countries' manufacturing trade has risen from 2 percent in 1991 to about 22 percent today. Countries that sell to the growing Chinese market or are locked in supply chains centered on China see the advantages of maintaining a stable exchange rate against the renminbi.
Trade is also propelling the rise of the renminbi outside East Asia. For example, the currencies of India, Chile, Israel, South Africa, and Turkey all now follow the renminbi closely; in some cases, more so than the dollar. If China were to liberalize its financial and currency markets, the lure of the renminbi 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 and towards China. Not only is China, by some measures, the world's largest economy in purchasing power parity terms, the world's largest exporter, and the world's largest net creditor (for more than a decade), but the renminbi bloc has now displaced the dollar bloc in Asia. The symbolism and its historic significance cannot be understated because East Asia, despite physical distance, has always been part of the dollar backyard.
America optimists 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 take note that even during the heady days of the Japanese miracle, the yen never came close to rivaling the dollar as a reference currency. 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 this regeneration is a necessary but by no means sufficient condition for retaining American preeminence in the face of China's rise.