One of the most widely cited strategies for reducing the likelihood of a hard landing involves confronting Chinese currency manipulation.

Proponents of this strategy argue that by hastening an appreciation of the yuan relative to the dollar, U.S. exports will become more competitive, which will act to reduce the trade deficit, and thereby serve to improve investor confidence along with the precarious climate of uncertainty. But as we shall see, this strategy involves significant tradeoffs – for the United States, Asia, developing countries, and the International Monetary Fund. (IMF) – that are likely to undermine its viability and effectiveness.

While the obvious benefit of such a strategy for the United States is
the potential improvement in its balance of trade, there could also be significant costs. First, such a strategy may, at least in the short run, end up having the opposite effect of that which is intended. As we have seen, the responsiveness of U.S. imports to fluctuations in the exchange rate is far from instantaneous. In considering the extent to which imports currently exceed exports, the higher dollar price of imported goods – resulting from an appreciation of the yuan – would in fact worsen U.S. trade performance, and contribute to even larger deficits (Chinn and Steil 2006). In the short run, a significant appreciation of the yuan could also be detrimental to the United States by cutting off the large amount of capital inflows that are necessary to finance its deficits. China’s policy of sterilized intervention

– and its resultant success in maintaining a devalued exchange rate

– is contingent upon its ongoing purchase of U.S. Treasury bonds.

Thus, if the yuan were allowed to appreciate, China would no longer have any need to purchase the vast number of Treasury bonds on which the United States so heavily depends.

In forcing China to appreciate, the United States also runs the risk of solidifying its position as a “coercive hegemony.” Already facing much anti-American sentiment around the world, the United States can ill afford to increase resentment by coercing China to pursue an economic agenda that is counter to its own autonomous policy goals. Yet, scholars like Goldstein reject the notion that confronting China would cause a hardening of its position, and argue that Chinese currency manipulation should be subject to the same kinds of criticism that are leveled at its military-build up.

China's mounting costs and the waning benefits (of maintaining an inflexible exchange rate system) will ultimately force China to reconcile its employment concerns with those of a moribund financial system (Rajan 2005), allowing China to maintain its own commitment to a gradualist approach to currency reform is much preferable to a coercive policy that calls for immediate adjustment. A policy that begets immediate adjustment is also likely to have adverse consequences in Japan. In considering that the economic relationship between China and Japan is more complementary than competitive, such a policy would conflict with Japan’s status as a net importer of Chinese manufactured goods, and its own comparative advantage as an exporter (to China) of raw materials and goods used for processing, such as steel and machinery. As highlighted above, a rapid appreciation of the yuan would hurt China’s export performance, and cause a general slowdown in the Chinese economy. Because processing makes up a significant proportion of China’s trade, such a slowdown would likely reduce the demand for Japanese exports in certain key industries (e.g. the steel and machinery industries). Indeed, for the Japanese economy, which has become increasingly reliant upon exports to China, a policy that induces an immediate appreciation of the yuan would almost certainly have a net negative effect (Kwan 2003).

Finally is the effect that such a policy might have on developing countries. It is certainly true that, like China, much of
the developing world relies on export-driven growth to fuel their economies. Many developing countries may therefore welcome an appreciation of the yuan, at least insofar as it makes their own exports more competitive relative to Chinese goods. A policy that results in an appreciation of the yuan may also reduce the flood of cheap Chinese imports that have often overwhelmed the nascent markets of developing countries, such as in Mexico or many African nations, for example. These positive outcomes are certainly deserving of consideration. But as we have seen, there is ultimately no guarantee that the kind of solution offered by scholars like Goldstein will produce the desired effects. Quite to the contrary, a rapid human rights abuses (Goldstein 2006). In dismissing the argument that citing China as a currency manipulator would provide the U.S. Congress with the justification it needs to enact protectionist legislation, Goldstein insists that the United States adopt a “tell-it-like-it-is” policy (Goldstein 2006, 13). But again, such a policy does not bode well for fostering diplomatic solutions or improving American sentiment. And it fails to provide China with a reasonable avenue for promoting its own agenda of ensuring political stability and promoting employment for its citizens.

Indeed, Chinese currency manipulation is a crucial part of this agenda,
and should not be considered akin to its military ambitions or alleged human rights abuses. To his credit, Goldstein acknowledges that trade retaliation is not the smartest lever to deal with currency manipulation, and that unilateral action by the U.S. may provoke just such a response (Goldstein 2006). His solution, therefore, is to “multilateralize” the issue by pushing the IMF to fulfill its original mandate to “exercise firm surveillance over the exchange rate policies” of its member countries, particularly China (Goldstein 2006,

Yet, it is doubtful that such a solution would actually address the problems at hand. From the perspective of many countries around the world, the IMF is simply a puppet or manifestation of coercive U.S. hegemony. Pressuring the IMF to recall its original mandate at a time that best suits U.S. interests is unlikely to improve the status of either actor.

I have already alluded to some of the tradeoffs for China in allowing their currency to appreciate. There is no question that the process by which China abides in maintaining an artificially devalued exchange rate comes at significant cost. Indeed, China’s sterilized intervention may lead to inefficiencies in the financial sector and significant problems of resource allocation (Mohanty and Turner 2006). Many scholars emphasize, in particular, the substantial opportunity costs that arise from China’s large accumulation of dollar reserves. For example, Zheng and Yi point to increased risks for the Chinese financial system, mounting inflationary pressure, and large losses of wealth incurred by a weakening dollar
 – all a result of China’s heavy foreign exchange accumulation and a consequent rise in speculative capital inflows (Zheng and Yi 2007, 23).

The policy proposals that Zheng and Yi offer to mitigate these risks, however, run counter to one that simply labels China as a currency manipulator. Their analysis, in encouraging only “gradual liberalization” and “small-scale diversification” (out of the US dollar), judiciously recognizes the tradeoffs that China faces in terms of having to ensure political stability and address “huge employment pressures” amid a “fragile financial system” appreciation of the yuan could induce severe instability in China that could have potential spillover effects among both industrial nations and developing countries throughout the region. And in the event that China was to harden its stance against liberalization, the possible protectionist leanings that might result in the U.S. from labeling China as a currency manipulator would only serve to foster anti-American sentiment among developing countries.

In conclusion, a strategy that aims to unilaterally confront Chinese currency manipulation is likely to be ineffective, and yield undesirable outcomes overall. And as Kirshner’s analysis suggests, true multilateral solutions (i.e., those that do not involve using the IMF as a tool for one’s own agenda) that involve cooperative action on exchange rates are probably beyond reach (Kirshner 2004). Nevertheless, the risk involved in a hard landing for the U.S. dollar requires planned action. The scale of global economic problems today may create an incentive for cooperation in the future, and so efforts to establish coordinated action on exchange rates should by no means be ignored. But the magnitude of the risk is such that the United States would do well to start with targeting solutions that fall directly within its immediate realm of control. Ultimately, in seeking to avert the possibility of a hard landing, a much more appropriate means would utilize “the chief policy tool that we can deploy with some confidence” –reducing the federal budget deficit (Bergsten and Truman 2007).