Floating yuan not enough to resolve trade imbalance (News Feature)

By Andreas Landwehr Jun 24, 2010, 11:35 GMT

Toronto - Last week's loosening of the yuan exchange rate may have bought China some diplomatic breathing space, but resolving the underlying problems in global trade is likely to take more than that, experts said.

The financial markets were enthusiastic when the yuan was unpegged from the dollar on Tuesday. But the widely predicted surge in value failed to materialize, as the yuan sank slightly in the first days of trading after an initial rise.

It should be remembered that a floating currency can move 'in both directions,' Chinese experts said, pointing to the strong dollar or the weak euro.

China's critics, who have long pushed for Beijing to relax its grip on its currency, are unlikely to be satisfied in the long run by such a soft approach.

But the initiative has earned Chinese President Hu Jintao some breathing room as he arrived in Toronto on Wednesday for the Group of 20 meeting.

US President Barack Obama had been pressuring China for months to let the value of its currency follow market pressures more closely.

Beijing's move may only be a partial concession to the demands of the US and others, but the issue has now disappeared from this summit's agenda.

But world leaders, however, face a more intractable problem that exchange rates alone cannot fix. Increasing globalization has created a vast trade imbalance between the United States, the world's largest consumer, and the world's largest exporter, China.

Twenty years ago, the US imports from China were 10 billion dollars higher than its exports. By 2008 the difference had grown to 268 billion dollars. This year the trade deficit reached 71 billion dollars for the period from January through April.

'In globalization, the world economy has become unbalanced. It needs rebalancing,' Professor Cao Yuanzheng of Beijing's Renmin University said. 'China has a huge surplus and the US has a huge deficit.'

Different savings practices are also an important aspect of the problem. 'China has a very high savings ratio while the US has a very low one,' Cao said.

Chinese people, wary of the lack of an effective social safety net, put on average 38 per cent of their income aside for leaner times, medical needs or their children's education.

US earners, by contrast, tend to live on credit. Even after the onset of the financial crisis, they saved only 3.6 per cent of their income in 2009.

'China exports and the US consumes,' Cao said, which is why China has the world's leading currency reserves estimated at 2.4 trillion dollars.

'China's surplus is put into the US capital market, the poor lending money to the rich,' Cao explains.

It appears this symbiosis has now run it course, according to experts. US earners must learn to save, and China needs to stimulate domestic demand.

A stronger yuan would help in this, by increasing the purchasing power of Chinese consumers, reducing the price of imports in China, and holding back inflation.

This would also be good news for both the US and the EU, whose exporters have their eye on the vast Chinese market.

But Chinese demand for foreign wares is not as strong as might be inferred from the figures, with 1 trillion dollars imported in 2009.

A quarter of that was raw materials, such as oil, iron ore or other minerals. One third was materials for processing into products for re-export. Only 43 per cent of Chinese imports by value was destined for domestic consumption.

'China's importance to the global economy is easily overstated,' said Ben Simpfendorfer, China economist with the Royal Bank of Scotland.

History also corroborates those Chinese experts who say that an appreciation of the yuan cannot single-handedly rectify the trade imbalance between the US and China.

From 2005 to 2008, while the yuan increased 21 per cent in value, China's trade surplus with the US almost doubled.