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The Weak Renminbi Is Not Just America’s Problem

by Arvind Subramanian, Peterson Institute for International Economics

Op-ed in the Financial Times
March 18, 2010

© Financial Times

Back in 1971 John Connolly, then US Treasury secretary, told his European counterparts that the dollar was "our currency, but your problem." Now it seems that China has returned that favor. Its currency has become a problem for the United States. Tim Geithner, the current Treasury secretary, has a damned-if-I-do-damned-if-I-don't choice facing him in mid-April, when he is required to pronounce on whether China is a currency manipulator.

The irony is that export subsidies and import tariffs are individually disciplined in the WTO but their lethal combination in 'an undervalued exchange rate' is not.

Branding China a currency manipulator would be explosive. Beijing would not take kindly to being chastised formally. It is likely to respond in kind, and it is safe to assume that changing its currency policy will not be part of that response. Yet ducking the issue also carries costs. Letting China off the hook for egregious currency action at this time would be an abdication of responsibility, a signal of weakness from the world's still-greatest power.

Is there a way out? There is, as Aaditya Mattoo of the World Bank and I have proposed. The key is to recognize that the renminbi is a problem not just for the United States but the world and, as such, requires a multilateral rules-based solution rather than a bilateral confrontation between Washington and Beijing.

The International Monetary Fund is, of course, the natural multilateral forum for addressing exchange rate issues. But the IMF suffers from problems of eroding legitimacy and inadequate leverage. Emerging market countries still complain that its antiquated governance structure does not reflect economic realities.

Moreover, the IMF has rarely, if ever, effectively influenced the policies of large creditor countries even where such policies have had significant negative effects on others. The IMF and its managing director have become more vocal in characterizing the renminbi as "substantially undervalued," but this has been water off the Beijing duck's back. The IMF is, sad to say, toothless.

The World Trade Organization is a natural forum for developing new multilateral rules. First, undervalued exchange rates are de facto protectionist trade policies because they are a combination of export subsidies and import tariffs. Second, the WTO has a better record on enforcement of rules. Its dispute settlement system, although not perfect, has been reasonably effective in allowing members to initiate and settle disputes. The WTO has greater legitimacy than the IMF—developing countries, even smaller ones, have been active in bringing disputes to the WTO. Tiny Antigua (population: 69,000) managed to successfully challenge US gambling laws.

What is needed is a new rule in the WTO proscribing undervalued exchange rates. The irony is that export subsidies and import tariffs are individually disciplined in the WTO but their lethal combination in "an undervalued exchange rate" is not.

The IMF would continue to be the sole forum for broad exchange rate surveillance. But in those rare instances of substantial and persistent undervaluation, we envisage a more effective delineation of responsibility, with the IMF continuing to play a technical role in assessing when a country's exchange rate was undervalued, and the WTO assuming the enforcement role.

How would this new rule be incorporated in the WTO? Essentially through negotiation. China would have to agree with its other trading partners in the WTO to negotiate new rules aimed at disciplining undervalued exchange rates. In return for such a commitment, the US Treasury secretary would desist from branding China a currency manipulator next month. To sweeten the pill for China, its major trading partners could pledge to grant China the status of a "market economy" in the WTO. This would have value because antidumping and countervailing duty actions are easier to take against nonmarket economies such as China.

Such an approach has several advantages. China would not be seen as a victim of bilateral targeting, but part of a cooperative approach to settle an issue that could well go beyond its currency. The remedy would be new broad-based rules rather than just renminbi revaluation. There would be a large collateral benefit too. Negotiating new and important rules would help revitalize the WTO, which has languished because of the unfinished Doha Round of trade talks.


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