Shopping for Currency Appraisals (Yuan Edition)

The Treasury department has been struggling to persuade China to let the yuan appreciate (the Chinese now engage in a dirty float in place of their former hard peg). Congress has threatened to impose trade sanctions if the Chinese do not let their currency float. However, the Chinese do not take kindly to threats, and their touchiness, and propensity to retaliate, have only gotten worse as China is taken to task over product safety.

Paulson looked to the IMF to act as an honest broker. But that move has backfired spectacularly, with the IMF declaring the dollar to be overvalued. Note that “the yuan is undervalued” and “the dollar is overvalued” are equivalent statements only from a two-currency perspective. The focus was supposed to be on the yuan and how the Chinese needed to stop meddling; now it has shifted to the dollar, and by implication, our low savings rate (the Chinese have taken the position that it is we, not they, that need to get their house in order).

Since the US didn’t get what it wanted, it rejected not only the IMF’s analysis but also the whole idea of determining the fair value of a currency. From an August 23 Bloomberg story:

Treasury officials criticized the IMF analysis for relying too much on trade in goods and services and not enough on capital flows. While the U.S. has run record trade deficits in recent years, foreign capital also continues to flow into the country at an even stronger rate.

The Treasury also was “skeptical about the notion of overvaluation for a market-determined exchange rate such as the dollar,” the report said.

The second blow to the IMF’s new mission came when Mark Sobel, a Treasury deputy assistant secretary, told Congress Aug. 2 that, while exchange-rate modeling offers “valuable insights, there is no reliable or precise method for estimating the proper value of an economy’s foreign-exchange rate.”

Hhhm, currencies are actually known for deviating from their “fair” values, meaning appropriate given the level of trade and services imports and exports, capital flows, and prevailing interest rates, for considerable periods of time. It also doesn’t seem to have occurred to anyone at the Treasury that the dollar might get a boost from its status as reserve currency.

Having repudiated the IMF’s reckoning, and taken issue with the idea of trying to determine proper currency prices, the Treasury has come full circle. It’s back to its original tactic of finding credible third parties to support its point of view that the yuan is overvalued. From Bloomberg:

U.S. Treasury Secretary Henry Paulson and French Finance Minister Christine Lagarde united in campaigning for China to let its currency strengthen.

“We have a total convergence of views that the Chinese currency is undervalued compared to the European and U.S. currencies,” Lagarde told reporters after meeting Paulson in Paris today. Paulson said China’s failure to let markets set the yuan’s value “is going to continue to be an issue.”

Since his May election, Nicolas Sarkozy has intensified French calls for China to let the yuan rise, echoing those made for the past five years by U.S. President George W. Bush. Both governments are concerned weakness in the yuan threatens their economic expansions and fuels disparities in global trade.

The French criticism of China has picked up as the euro rose to a record against the dollar and second-quarter growth slowed. “France is now much closer to the U.S. on the yuan,” said Gilles Moec, an economist at Bank of America Corp. in London. “We’re going to see more complaints from Paris as the euro creeps higher and hurts growth.”….

Paulson welcomed Lagarde’s comments. “It’s helpful to have the major economic players express their view,” he said.

This process of soliciting sympathetic official views about the yuan bears an uncomfortable resemblance to ratings shopping. However, while assessments by Moody’s, S&P and Fitch are seen as equally valid by most investors, few would put the French government in the same league on currency matters as the IMF.

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