beyondbrics

The US and China just spent two days discussing their main economic and security issues and they barely mentioned the renminbi, the issue that only a few weeks ago seemed to have the potential to spark a trade war. So where do things stand now?

The US still wants Beijing to revalue its currency sooner rather than later. But, it seems, the Chinese side said just enough to appease its American critics for the time being.

Admittedly, President Hu Jintao’s pledge that “China will continue to steadily advance the reform of the formation of the renminbi exchange rate mechanism” only repeats a standard formulation that Beijing has used often in the past. But he did not snub his visitors by trying to argue, as he did in March, that the renminbi is not undervalued. And he gave no indication that the Euro crisis has led China to put the idea of abandoning its dollar peg on hold, as has been widely reported in Chinese media.

Tim Geithner, meanwhile, went out of his way to avoid public pressure over the currency. That is probably just good tactics – the realisation that open criticism could easily be counter-productive. However, it also leaves the tantalizing possibility that he knows something he is not sharing. As Mark Williams at Capital Economics argues: “It seems reasonable to conclude that US officials are still fairly confident that exchange rate reform is imminent.”

Geithner still has to deal with the Treasury department’s report on whether China (and other countries) manipulates its currency, whose publication he delayed in April. Asked yesterday when it would come out, he would only say: “That time will come.” After the initial delay, Treasury officials indicated that they were waiting to see what happened in the run-up to the G20 summit in late June. If there is no movement by then, Geithner will find himself in an increasingly uncomfortable position – especially if more developing economies also join the chorus calling for a stronger renminbi.

And while the collapsing Euro has given China a tactical reason to hold-off on a change in policy, some economists believe that the European crisis means that China needs to make even more decisive steps to rebalance its economy than were needed before. Michael Pettis at Peking University argues that a number of European countries with large trade deficits will not be able to get the capital inflows to keep financing such deficits. The result is that big surplus countries, such as Germany or China, will have to make a large adjustment:

“The argument – very seductive on the surface but also, like many other seductions, a little dangerous – is that with a weak euro the RMB has effectively strengthened against China’s trade partners, so China has “done its bit” to help in the global rebalancing. But I would argue that the problems in Europe, rather than partially resolve RMB undervaluaton, actually make the global rebalancing much more difficult and require more a aggressive, not a less aggressive, response from China.” (It is a long posting but worth reading.)

The tactical truce over currency issues held firm this week. But a summer trade row is still a possibility.