The theme of recent discussions has been whether China is deliberately keeping its currency, the renminbi, undervalued in order to keep a trade surplus, despite continuing US pressure on China to allow the currency to appreciate. Chinese premier Wen Jiabao has rejected such claims.
"In Europe we have secretly been hoping for the end of US dollar dominance for years," said Michala Marcussen, London-based head of global economic research at Societe Generale corporate and investment banking, at a recent media briefing in Hong Kong. "Is it really the end of US dollar dominance? I would say no, but it is the beginning of the end of a long story."
The liquidity problems that China is facing today are both internal and external in nature. SG chose not to focus on internal liquidity problems as it believes these are under control. The external liquidity problems result from hot money inflows into the country and can be resolved by a one-stop revaluation of the renminbi, according to Marcussen.
Such a move would also help resolve China's growing inflation problem. SG believes, in contrast to consensus views, that this one-stop revaluation could occur as soon as summer 2010 and that, somewhat stating the obvious, ultimately China will be guided by what will benefit the Chinese economy, rather than obey the demands of the US.
The primary reason why the US wants China to appreciate the renminbi is a desire to ease its trade deficit with China. Renminbi appreciation will raise the cost of Chinese imports in the US and thereby increase the competitiveness of US goods. Secondly, the US is keen to reduce the value of Treasury debt held by China, which has been on the rise fuelled by a large US budget deficit and a two-decade high US unemployment rate of more than 10%. And thirdly, the US is keen to sustain its global currency dominance and contain the emergence of the renminbi, a role which would be under severe threat if China were to allow the renminbi to be fully convertible.
SG forecasts China's trade surplus will dissipate by the end of the year as a result of fresh supplies of Treasury bonds and its infrastructure product offerings. "The question that arises now is who will be buying US Treasuries," said Marcussen. "We believe domestic US investors have ample capacity to buy US Treasuries, in fact their allocations are at historically low levels."
History has demonstrated that a strong currency may not necessarily balance a trade surplus. The Plaza Accord of 1985, named because of its location at the Plaza Hotel in New York, was an agreement between the governments of France, Germany, Japan, the United Kingdom, and the US. The US was suffering from a large current account deficit at the time and the five countries agreed to allow the US dollar to depreciate in relation to the Japanese yen and the European currencies.
The dramatic depreciation of the US dollar successfully reduced the US trade deficit with Europe but not with Japan, illustrating that the strength of the yen did not wipe out the Japanese trade surplus. "The US current account deficit problem [with China] is not a question of trade balances but of internal balances in China," said Marcussen.
SG concludes that the US dollar is "the new currency in the middle", predicting an appreciation against the euro and yen, but a depreciation against major emerging and commodity currencies. Marcussen described a one-stop renminbi revaluation as "a sensible move to kill all the birds with one stone".