Appreciating China: The Implications of a Stronger Renminbi

The economic relationship between the U.S. and China has become more complex than most people could have envisioned a decade ago.The economic relationship between the U.S. and China has become more complex than most people could have envisioned a decade ago.The dispute over China’s currency, the renminbi (RMB), is a perfect example of the interdependence between the two countries. In practice, every change in the value of a currency always has positive and negative effects on different groups of people. For example, China's cheap RMB has helped bring jobs to huge numbers of laborers in China, and supplied U.S. consumers with cheaper products. On the other hand, less-skilled American laborers in import-competing industries have been replaced by their less-expensive Chinese counterparts, and Chinese consumers have had to pay higher prices as some of their country's supply is going to exports.If we reverse this, a rise in the RMB's value will hurt Chinese labor and U.S. consumers that buy Chinese-made goods, but would benefit American low-skilled labor and Chinese consumers. Therefore, arguments can be made for both indefinitely maintaining the RMB’s current value, and for its continued gradual appreciation. Today, however, there is increasing pressure to let the RMB appreciate as concerns like inflation in China and huge trade deficits in the U.S. weigh heavily on decision-makers on both sides of the Pacific.An appreciating RMB can be translated as a “strong” RMB, meaning that it has more power relative to other assets. To put this in context, since the end of World War II the strong U.S. dollar has dominated the world economy, sharing the stage in recent years with the euro. (In 2010 the dollar made up 46% of international currency use with the euro accounting for 31%. ) Therefore, the majority of international economic activity primarily occurs through one of these currencies. Larger shares of a country's currency used in cross-border activities—primarily debt and deposit markets, trade settlement, and derivatives—give it the benefits of stable prices (because of low exchange-rate volatility) and lower interest rates (because of high demand in the money supply).A strong RMB, then, would give China the benefits associated with an international currency like the dollar or euro. But restrictions on cross-border movement of the RMB, designed to protect its value, have so far prevented this from occurring. As China pursues a strong currency policy it will eventually have to start removing these restrictions, and for every capital control that is relaxed or removed, market forces become that much more powerful. Anticipating this, China has already started putting small-scale projects in place to learn how to use the RMB as an international currency.There are also political effects from such a move. First, China will make relative political gains against the United States in East-Asian trade and cross-border financial cooperation, solidifying itself at the center of the region's economy. Second, the world will become less reliant on the U.S. dollar, reducing Washington's ability to continue funding government deficits and increase the need for deep public-spending cuts. Third, as a result of the aforementioned effects, the United States will increasingly lose its ability to lead the world economy. On the other hand, the two countries' trade imbalances will move toward equilibrium, trade will increase, and the whole world will benefit from larger economies of scale, better allocation of global resources, and deeper financial cooperation. While these factors may change, the real trend is clear: a relatively stronger China and a U.S. in relative economic decline.There is a broad public debate in China on just how long this currency regime will remain sustainable. China's whole economy has been built around its export model and a key part of that has been the currency policy. Institutions to protect the system have become deeply ingrained and it's politically impossible for Beijing to simply change the policy.One all-around positive trend of a strengthening RMB will be the emergence of a massive new market of Chinese consumers over the next decade as the country's buying power grows. Developing this market, however, will require a broad set of reforms and a move towards better governance. In this regard, Beijing has already made reforms improving health care, education, and pension systems, reducing the need for China's high domestic savings. As Chinese consumers feel safer, they will spend more of those savings, strengthening the economy. Therefore, assuming that RMB appreciation is a reality, the role the United States and other international actors play in the development of the currency regime will be relatively minor.There has been strong public pressure coming from American labor groups for RMB reform. However, much of the pressure coming out of the United States focuses only on a narrow slice of the RMB debate - its impact on U.S. welfare. Given the economic nationalism it stirs up in China, these exhortations are likely to do more harm than good. Steven J. Woodard is a final year graduate student in the International Economic Affairs program at the George Washington University's Elliott School of International Affairs. His research focuses on U.S.-China economic relations and emerging regional financial systems, and he has experience working with the Department of Commerce in Beijing as well as teaching Chinese foreign policy at the Alliance for Global Education. This image is being used under Creative Commons licensing. The original source can be found here.