Every few months Beijing will find itself pressured by foreign governments – usually developed nations – and well-meaning international organisations to revalue the renminbi.
The latest shot across the bow came from a group of US senators, which on March 16 introduced legislation aimed at forcing the US administration to take a tougher stance on China.
“The impact of China's currency manipulation on the US economy cannot be overstated,” they said. “Maintaining its currency at a devalued exchange rate provides a subsidy to Chinese companies and unfairly disadvantages foreign competitors.”
This comes after Chinese premier Wen Jiabao said over the weekend that the renminbi was not undervalued.
Like the many exhortations that went before it, this latest attempt by US lawmakers is likely to fall on deaf ears.
Last July, the governing body of the International Monetary Fund (IMF) urged Beijing to hasten appreciation of its currency. That has had no effect at all.
This current salvo is more serious that that, as it could eventually lead the US Treasury to label China a currency manipulator, which gives it the power to impose stiff penalties if it chooses to. The department has until April 15 to decide if it will make that call.
It is worth remembering that despite years of heated rhetoric, the US has not branded China a currency manipulator since 1994. However, things may be different this year.
To take the cynical view, in the run-up to the mid-term elections in November, lawmakers need to be seen to protect America’s economic progress. China just happens to be an easy target.
A report by the AFL-CIO, a federation of trade unions, finds that China’s fixed peg artificially lowers the prices of its goods by 40%.
Robert Scott, senior economist at the Economic Policy Institute, has also been quoted as saying that China’s currency policy has cost America 1.5 million to 3 million manufacturing jobs.
If the US were to play hardball and label China a currency manipulator, it must be prepared for the fall-out – which could be an ugly sight.
At the very minimum there will be harsh rhetoric on both sides, which would be a blow to investor confidence globally.
If the US were to take it one step further and impose sanctions, a full-blown trade war is not beyond the imagination. If that were to happen, it would be impossible for US president Barack Obama to reach his goal of doubling US exports over the next five years.
Beijing will not take such a slap lightly, either. They will likely dig their heels in allowing renminbi appreciation and delay it for a considerable period – ironic, to say the least.
It could retaliate by having its sovereign wealth fund and other state-owned companies shift their investments away from the US, bringing that vast pool of money to Europe, Latin America and Asia.
China is also likely to decrease its purchase of US Treasuries sharply, accelerating an on-going trend. That is the consequence of antagonising your largest creditor.
This back and forth has added uncertainty to the time-line and the degree of appreciation. Although most still tip the renminbi to appreciate this year, fewer are standing by the bullish calls they made earlier.
Analysts had believed the renminbi would increase by between 3% and 8% this year. However, the nine-month non-deliverable forward market is pricing in just a 1.7% appreciation by the end of the year. This is also a clear drop from the 2% rise forecast by traders last week.
Foreign politicians often have little appreciation for what Beijing has to juggle. It knows that the renminbi will need to appreciate after being pegged to the US dollar at Rmb6.83 since mid-2008. But it cannot do so unless it is certain that the economy is back on a firm footing.
Beijing’s other fear is that by allowing currency appreciation, it would open the gates too hard to control hot money inflows. That would not only be a disruptive force, but could easily push up asset prices to bubble heights.
China’s slow and steady approach is the right one. No amount of external pressure will encourage Beijing to revaluate the renminbi before the time is right.