Why China resists currency reform

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Next to Mao, Ben looks sad (Petar Kujundzic/REUTERS)

The chorus of voices criticizing China’s stubborn resistance to reforming its controversial currency regime and allowing the yuan to appreciate keeps getting louder. Outrage in Washington has been growing, the European Union recently called on China to let the yuan rise, and even officials in usually polite Japan spoke out against China’s stance last week. China is sure to take a diplomatic beating at the G20 summit in Seoul in November. China needs currency reform to aid its own economic development as well. But China continues to scold the world, insisting that the value of the yuan is nobody’s business but China’s. And although the yuan has started slowly creeping upward in value, it’s still risen a mere 2.2% against the U.S. dollar since a two-year de facto peg to the greenback was lifted in June.

Why does Beijing refuse to bow to the inevitability of yuan reform? China wants its currency to become a major force in world trade and finance, and the only way to achieve that is by making the yuan’s value more representative of market forces. So it’s really just a matter of when, not if, China will let the yuan free. In the meantime, Beijing’s central bank keeps amassing more and more dollars it doesn’t want in the process of resisting the appreciation of the yuan. Currency reserves topped $2.65 trillion in September.

The usual reason offered for China’s stubbornness is that Beijing fears that a rapidly appreciating currency would undermine the competitiveness of its job-creating export sector and force domestic reforms that could be destabilizing to the economy. That’s true. But there are deeper, more fundamental reasons why Beijing is so wedded to controlling the yuan:

(1) China is still really really poor;

(2) Alleviating that poverty is the sole basis for the legitimacy of the ruling regime; and

(3) Chinese leaders are thus terribly afraid of their own, restive populace.

We forget amid all of the China-is-taking-over-the-world talk that it’s still way way way behind the advanced economies of the West. Sure, China is now the second largest economy in the world, but with the world’s largest population (1.3 billion) that doesn’t add up to very much per person. China’s GDP per capita in 2009 was only $3,735, compared to $45,934 in the United States, according to IMF data. China is even poorer by the standards of other emerging markets. Brazil’s per capita GDP is more than twice as large; so is Mexico’s. And many parts of China are only now beginning to feel the impact of its rapid development – especially in the countryside, still home to some 900 million Chinese. According to the World Bank, roughly 200 million Chinese subsist on less than $1.25 a day. That’s about the size of the population of Brazil.

So China acts in what it perceives as its own interests – hoarding as much of the world’s exports and as many of the jobs as it can – since it still has a lot of work to do at home lifting its own people out of poverty. When you’re poor, you tend to think more about feeding your own than acting in the best long-term interests of the global community. We can argue that China would be economically better off if it let the yuan’s value be determined by the market, but Beijing wants to ensure its own people are protected from the possible fallout of such a step – as any government should. We all ought to be sympathetic to that.

In China’s case, however, achieving ever-greater gains in income and public welfare take on special importance. It’s true of course that all politicians rise and fall with economic performance. (Look at the struggles of Obama’s Democrats today.) But in China, fattening people’s pocketbooks has become the primary – in fact, the only – way in which the Chinese regime maintains its legitimacy. Unlike the U.S. or other emerging countries such as India, the authority of China’s government doesn’t come from the ballot box. And China’s current leaders are far removed from the days of Mao, who earned the right to rule through conquest and revolution. Communism is dead in China, despite the name of the ruling party. Deng Xiaoping forever hitched the perpetuation of Communist Party dominance to the delivery of economic welfare. The Communists’ rule is based on a grand, unwritten contract with the Chinese people – you let us be dictators and we make you rich. The ideology of Marx has been replaced by the lure of Louis Vuitton bags and Buicks. If the Communists don’t keep the good times rolling, they run the risk of getting rolled over. The contract breaks down and the Communist regime has no reason to exist.

That’s why the government flies into a panic every time growth slips towards 8%, or why Beijing embarked on a credit boom of historic and potentially dangerous proportions to keep growth alive during the Great Recession. And that’s why the yuan stays where it is. In my opinion, the leaders in Beijing see a link between the yuan and their very survival. They are well aware that if things go economically wrong, their necks are on the line. Why take a risk and dramatically alter your yuan policy because the Americans are upset? Obama isn’t nearly as scary to Beijing’s mandarins as their own citizens. We have to remember that China is going through a fantastic process of nonstop social change, brought about by the forces of rapid development. Cities are swelling with new residents streaming in from the farms, provinces are competing with each other for jobs and investment, hundreds of millions of people are racing to grab their new opportunities all at once. This process has created a society in almost constant flux. There is a lot more turmoil in China than the government likes to let on. I recall visiting a factory in the industrial enclave of Shenzhen a few years back. The factory was located on an upper floor in a large building that housed several others. As I ascended in an elevator with the factory manager, the doors opened suddenly. I got a glimpse of a mob of workers screaming in a darkened room. The doors shut. “That’s not my factory,” the manager accompanying me said. Turns out the workers were furious over unpaid wages. Such protests and near-riots aren’t unusual in China.

If more workers don’t get their paychecks, you’re looking at a potential explosion. I’m not predicting such a crisis will ever happen. But short of political reform – which is much less likely right now than yuan reform – China’s leaders have to take that possibility into account whenever they set economic policy. So for Beijing, it’s economic growth at all costs, however the world might grumble about it. China’s yuan policy won’t significantly change until the regime feels secure enough to change it. Full stop.