Money, at least as a concept, is worth more now than ever. In the modern world, the majority of transactions occur in relation to a single paper currency with arbitrary value. Monetarism unlocked money as a commodity, and has enabled states to manipulate the flow of currency to optimize human transactions. With the aid of information technology, these transactions can occur inconceivably fast. Yet, like all commodities, money can be controlled, and in manipulating its flow comes power. The international flow of money challenges our ideas of national sovereignty, and by that token, those who control the flows challenge our definition of competitive advantage within the global marketplace.
Enter the People’s Republic of China (PRC). To some American policymakers, China is the preeminent currency manipulator of our time. Like Japan, our latter day protectionist, we have blamed the PRC of using unfair tactics—among which, monetary policy—to develop at our cost. Unlike Japan, the PRC has yet to give in to international pressure.
To wit, a slow fury has manifested among politicians and their disaffected blue-collar worker constituents. They blame China of using a combination of a fixed exchange rate and massive flows of dollar reserves to anchor their currency, the renminbi (RMB), to a level far below the US dollar. The value differential makes for uncompetitive pricing of products; their exports win out to the degree that it has whittled away the American heavy industrial sector.
One way or another, development must continue. Chinese Communist Party (CCP) members must develop negotiation strategies to counter the increasingly persuasive and emotional arguments of Washington in order to retain full control over their nation’s developmental destiny. In my mind, the best strategy for winning this contest resembles the famous TIT FOR TAT strategy: nice, retaliatory, forgiving, and clear (Axelrod 1984: 54).
First, with the historical context of the RMB revaluation conflict, I will argue that the current exchange rate regime has evolved from a combination of harrowing events. Inflationary spirals put a premium on state involvement in the currency swap market, an environment of “hot money” incentivized capital controls in tandem with fixed exchange rates. When these policies brought about rapid growth, China became reticent to change and increasingly dependent on inflation controls via sterilized foreign exchanges. In the eyes of scholars both East and West, this volatile combination has to change.
Second, I will sketch this conflict as a game, one featuring a framework based on the assumption that China must keep authority over its monetary policy. I will argue that given the players and their interests, and with consideration of negotiation theory, this game is one that currently unfolds away from the bargaining table, but may be headed there in the near future. However, before making a case for a particular negotiation standard, I suggest that there are some important limitations for creating a negotiation strategy, for instance, the difficulty of realistically representing asymmetrical information between players.
Finally, I will theorize a negotiation strategy considering escalation on three levels.
The first level, where we are presently, occurs prior to formal negotiation. China’s prerogative is to keep negotiations informal for as long as possible. Yet, escalation is still the next best solution given the immediate prospect of sanctions.
The second level, negotiations, puts China’s authority over its reforms into peril. Although the best means for ending bilateral tensions and achieving meaningful reform can probably occur through negotiations concentrated on the appreciation timetable, worse comes to worse, China can simply use delaying techniques to buy themselves time to implement their own reform.
In the third level comes economic sanctions, and on this subject I agree with Lawrence H, Summers’ statement that this conflict is “a balance of financial terror” (Goldstein and Lardy 2008: 349-353); escalation ought to be avoided by all parties, but this is no guarantee that it will not happen.
Chinese monetary policy has changed a great deal since the beginning of reforms, yet the RMB conflict has some degree of historical contingency.
To wit, the experiences of three stages of Chinese economic reforms informed policy makers’ prerogatives. First, in the first stages of reform in the 80’s, as China was hit by a series of inflationary cycles, policymakers opted to take on greater amounts of foreign exchanges and allow firms greater freedom to swap exchanges.
Second, the rise of China in the 90’s brought the pegging of the RMB paired with capital controls; these conditions were ideal for the foundations of a robust exchange regime, but also starting a dangerous trend with rate of saving.
Third, in the 00’s, a new source of tension appeared: as China began to accrue foreign exchange at an accelerated rate, the US began to raise some serious questions.
1.1 In the First Stages of Reform
There is specific merit in exploring the events that led the leadership of the PRC to peg the RMB to the dollar in 1994. Given the background of three inflationary cycles, one more dangerous than the last, one may explore the peg not only to help unlock the reasons why policy makers are invested in the system, but also to explain how foreign currency—most notably the dollar—remains a crucial element to the financial stability of the Chinese economy.
The first inflationary cycle occurred in 1981 during the shaky first years of reform. Vice Premier Deng Xiaoping was beginning to assert his authority over the CCP. To finance his campaign, Deng pushed for generous fixed asset investment and overshot his 25 billion yuan budget for 1980 by 300%. The resultant increase in the base money supply generated great inflationary pressure (Shih 2008: 94-99).
Despite the momentum for reform manifesting from key political victories over Hua Guofeng’s conservative faction, reformers too were divided, and Deng’s camp squared off against head of the Economic and Financial Commission Chen Yun’s. Friction from this conflict influenced anti-inflationary reforms. An austerity program featuring a lending balance (xindai pingheng) aimed at curtailing the growth of money supply.
Meanwhile, in 1980 the Bank of China (BOC) opened its first foreign exchange adjustment center (waihui tiaoji zhongxin), and then the following year engineered the internal foreign exchange settlement system (neibu jiesuan zhi) (Liew and Wu 2007: 66-70).
Between these two systems, foreign trade companies were allowed to trade in foreign exchanges accrued from export sales at the rate of 2.8 RMB per dollar. For the first time, foreign currency could be exchanged without significant domestic currency losses (74-75).
The second inflationary cycle of 1985 also occurred alongside heated factional tensions, wherein Chen Yun took the first signs of inflation as an opportunity to pressure Deng into calling for an economic retrenchment. Non-performing loans (NPLs) also manifested, and in response technocrats in the People’s Bank of China (PBOC) created the first overtures for an independent national banking system (Liew and Wu 75-80, 80-4; Lardy 1992: 124-127).
Victor Shih posits that the factions, bickering over the degree of influence the central government should have on economic growth, found common ground when they accepted the largely anti-inflationary prescriptions of the banking technocrats (2008: 122-123). And so, in 1985 the government unified the dual exchange rates for trade at the internal settlement rate and opened the first foreign exchange adjustment centers.
In doing so, they attempted to channel foreign exchanges into the accounts of foreign invested enterprises (FIEs). Further, by facilitating exchange swaps between FIEs, the government aimed to lower the foreign exchange costs for acquiring RMB. Finally, officials began to manipulate the fixed rate of the RMB as a means to export promotion, with mixed success (Liew and Wu 2007: 72-75).
The third inflationary spiral occurred in 1988. Although in the mid-80’s there seemed to be little inflationary pressure, indications of overheating started to appear in 1987. By 1988, double digit inflation had gripped major cities across China. In reaction, once again the State Council agitated for retrenchment. Favoring price liberalization and regulation of fixed asset investment, Deng and Zhao Ziyang spurned the State Council.
Unfortunately, these policies were unable to rein in the rampant inflation. The subsequent Tiananmen Square massacre and corresponding upheaval at the highest echelons of the Party constrained Deng’s reform options and locked him into conducting a three-year retrenchment period.
By 1992 prices had stabilized, but with the conclusion of fiscal austerity, a massive influx of foreign exchange caused the RMB to depreciate rapidly. Officials eventually intervened through the swap market, putting the brakes on as the currency approached 7 RMB per dollar (Shih 2008: 127-142).
Ultimately, the 80’s was not only a time of influential reforms, but also of repeated inflationary cycles. Victor Shih’s research has suggested a deeper meaning for the reoccurrence of inflationary cycles: economic centralization would acquire growth through price stabilization, but prosperity was flummoxed as generalists intervened through expansionary fiscal policy (Shih 2008: 62-63).
In short, the account the mixed outcomes of the reforms are best reiterated through Deng, who said during his Southern Tour: If we issue a bit too much currency, or if price fluctuation is a bit too large, or if redundant investment is a bit too serious, we create some waste. But, how should we comprehensively view those five years of high-speed growth? (1984-1988)…In my evaluation, the high speed growth in those five years achieved quite a bit.
1.2 The Rise of China
Social scientists have continually discussed the impact of monetary policy on the rise of China. Some issues in monetary policy are not particularly contentious, for instance, cheap currency undoubtedly contributes to a nation’s export orientation. But there also are more controversial issues, such as the role of monetary policy in attracting foreign direct investment (FDI).
China’s exchange rate regime emerged through the 1994 reforms and was a major factor for China surviving the 1997 Asian Financial Crisis (AFC) relatively unblemished despite criticism from policy analysts abroad. For this reason, the connection between the peg and China’s rise is yet another contentious topic.
The first years of the 90’s saw Deng searching for competent replacements in the aftermath of the Tiananmen shake up. One of his most prominent disciples was Zhu Rongji, who rose to become the economic tsar of the Jiang Zemin regime. Zhu was a banking technocrat known for designing effective anti-inflation policy. In 1994, after the swap rate plunged fifty percent, authorities under the direction of Zhu fixed the swap rate at 8.7RMB per dollar with a .3 percent band and unified the official and swap rates at this fixed level.
Because this reform would eventually allow for the conditionally convertibility of the RMB for current account transactions, it had profound implications on the purchase of foreign exchange reserves. Zhu and his fellow technocrats did not anticipate the deeper implications of the reform; they simply conceived of it to prevent mass capital flight in the case of hyperinflation, articulated by the dictum “easy to get in, hard to get out” (kuanjin yanchu).
Nevertheless, with the unification of rates, the RMB began to appreciate and remained stable for years at the 8.3 RMB per dollar range (Shih 2008: 151-163). The currency stability came with a side effect: periodic exchange market intervention and sterilization was necessary to limit inflation due to excessive credit (Goldstein and Lardy 2008: 13-16).
A stress test for this system occurred with the AFC. Neighboring economies were toppled left and right, many of them acceding to the wishes of the International Monetary Fund (IMF) by adopting a floating exchange rate. China too faced deflationary pressure, and factions within contemplated revaluation and exchange rate regime change.
One side, the PBC and the State Development and Planning Committee (SDPC), wanted no devaluation and moderate and fixed exchange rate flexibility (respectively). Another side, the Ministry of Finance (MOF) and the Ministry of Foreign Trade and Economic Cooperation (MOFTEC), preferred devaluation and a fixed exchange rate. Zhu, then head of the Central Leading Group on Finance and Economics (CLGFE), pushed for a no-devaluation policy. A fixed exchange rate was useful for deterring “hot money”, but by itself was not sufficient to reignite the engine of development.
Infrastructural spending facilitated by the PBC was responsible for reinvigorating the economy and buoying the rest of East Asia (Grimes 2009: 122-131). Hence, in the 90’s Beijing had found a policy capable of keeping the RMB stable: PBC purchases of foreign exchanges. By injecting the foreign currency into the market (via the sterilization process), policymakers found a way to provide excess capital liquidity without altering the base money supply.
However, the rise of foreign exchanges to a higher rate of savings. Starting in the 2000’s, analysts would begin focusing on this indicator as the handmaiden of global economic disequilibrium.
1.3 A New Source of Tension
For the last decade, Chinese monetary policy has created a great deal of tension in the Sino-American relationship.
China’s new found position within international production chains and its admittance into the World Trade Organization (WTO) in 2001 has conferred the prestige and responsibilities of a great power. Yet, the PRC was also blamed for destabilizing the international political economy. In particular, the US began to suspect that China’s previously successful foreign exchange regime gave the nation an unreasonable competitive advantage. In 2000 and 2001, even as Zhu extended lines of credit to rural cooperative credit unions and to small and medium enterprises (SMEs), lending was still relatively restricted.
This changed as Jiang, arguing that firms and local banks need closer ties to ensure steady growth, influenced the PBOC to simplify lending procedures and increase lending rates. Jiang’s aims were to dismantle the highly centralized financial system Zhu put into place. Financial offices previous designed to oversee PBOC and state bank branches in limiting NPL and facilitating repayment efforts were employed to pressure banks into bankrolling local firms and public projects.
Even as Wen Jiabao succeeded Zhu in 2003, the money supply was ratcheted up and the growth of fixed asset investment reached a ten-year high (Liew and Wu 2007: 91-102). Despite rapid capital expansion, China’s comfortable fiscal position and steady manipulation of interest rates seemed to ward off inflation. Dollar reserves and a bounty of FDI from American investors caused China’s balance of payments surplus with the US to grow at a mind-boggling rate. Congress took note of the currency manipulation.
On February 3, 2005 US senators Charles Schumer (D-NY) and Lindsey Graham (R-SC) introduced S. 295, a bill threatening Chinese products with tariffs if the RMB was not appreciated. Ostensibly in reaction to this threat, on July 21, 2005 China took the RMB off its fixed rate anchor and gently appreciated the RMB by 2.1 percent, and has been appreciating 6 percent per year ever since (Burdekin 2008: 33-41). Beijing’s appreciation of the RMB, merely a token gesture, was not sufficient to reverse the imbalances.
China has continued to run a massive surplus with the US, even employing a sovereign wealth fund for a smoother utilization of its massive exchanges account. Congress has proposed numerous counterattacks— HR 2942, S 1607, and S 1677 in 2007, S. 1254 in 2009, and in 2010 circulated a petition with 150 signatories from congress demanding China revalue the RMB. Each of these complaints has attempted to leverage economic sanctions to assure Chinese reform. Obviously, the conflict of this situation has increased.
Overall, it is possible to get a sense of how China’s experience as a transition economy has shaped its monetary policies. First, in dealing with inflationary cycles, the state set a precedent of intervention into the domestic currency market.
Second, China’s experience with regional financial crisis not only created an attachment for a pegged exchange rate regime but also spawned a structure designed to insulate the economy from inflation.
Third, greater amounts of foreign reserves were necessary to create a clear path for China’s climb into the WTO and the G-20, but such policies has come at the expense of congenial relations with the US. The time of monetary policy reform is nigh.
2. THE RULES OF THE GAME
With the background of the conflict thus discussed, it is now possible to discuss some pertinent issues behind sketching the hypothetical motions to solve this conflict. While there is a great deal of literature prescribe policies to deal with this conflict, few deal with how China and the US can implement the ideal policy prescriptions.
Broaching the topic of how to negotiate around the conflicting interests of each party is necessary for implementing a policy of mutual benefit, and there are three areas that need clarification before one can sketch out how negotiations might play out. First, I will explain some basic assumptions going into this particular scope and how it will shed light on the nature of strategizing, particularly in the sense that gambits shape the arena of debate.
Second, I will explore the players of the game, explaining the goals they bring into play, and briefly presage how the players’ gambits may affect coalition building. Third, I will state some caveats intrinsic to my scope.
2.1 The Renminbi Conflict as a Game
Analyzing the renminbi conflict as a game entails thinking strategically about a hypothetical moment of bargaining. While a purely analytical scope can expose the core interests of each nation’s policymakers and their overall perspective on how economic growth ought to occur, this scope cannot document the precise amount of weight an actor may place on a given interest. An example of this point in action is that parties are free to frame ambivalent terms depending on their negotiation strategy.
At the bargaining table, one is free to lower the visibility of a contentious phrase or make it as high profile as slander. Viewing the conflict as a game is useful for prescribing strategies for diplomatic action. There are many reasons to think about conflict strategically, and with conflict, human beings have the capacity to plan even in the absence of a structured framework. For one, people approach conflict with limited frontier of ambitions: to make somebody understand principles (i.e. abstract details, such as human rights); to decide on value (i.e. material details, such as a trade agreement); to build personal rapport (usually between elites or classes of elites); to minimize tension (e.g. by presaging action, making your side seem more predictable); to assert authority. These goals can coexist in a single debate, and they are defined by their practicality.
Our basic means for satisfying our ambitions occurs through appeals, including: appealing to emotions (e.g. to empathy for a class of people worth defending); appealing to overarching principles (i.e. natural rights); appealing to line of reasoning (i.e. that a conclusion is implied or assumed in the broader argument set forth); appealing to consequences of an action; appealing to one’s personal character (i.e. between elites).
In this sense, it is not necessary to create a rigid framework to discuss conflict resolution.Yet, it is still worth consulting a few tomes on the subject of negotiation theory. The vast majority relies on the work of Howard Raiffa (1982) and Max Bazerman (Bazerman and Neal 1992), and their framework seems to work at a basic level with the RMB conflict. To them, negotiating games are comprised of four dimensions: issues, parties, levels, and linkages. Although the simplest analyzed conflicts occur between two parties with a single issue, in a single level with a single round, the unique thing about negotiations in analysis is that the original actors party to negotiations can influence which issues emerge, how they emerge, which additional actors are included, and which levels negotiations take place on; negotiation theory thus accounts for the evolutionary aspects of negotiation.
Each dimension is variable, and within the context of a conflict bound to change—indeed, by limiting a conflict to simple negotiations, one may unduly limit the ability of parties to solve their problems. By this token, Devereaux, Lawrence and Watkins (2006) draw upon the framework of the emergent process of negotiations to discuss US trade negotiations, including the Sino-American negotiations just prior to China being admitted to the WTO. In doing so, they have created a solid approach to strategies in complex negotiations in two particular faculties.
First, they document the strategies players can take in complex negotiations through a two-by-two matrix that contrasts actions away from (i.e. preparing for negotiation versus unilateral actions) and at the bargaining table (i.e. bargaining within versus about the rules of negotiation).
Second, they argue that players can exercise seven different strategies: organizing to influence, selecting the forum, shaping the agenda, building coalitions, leveraging linkages, and creating momentum (Devereaux, Lawrence, and Watkins 2006: 18-35).
Ultimately, this framework elucidates how one should approach negotiations by giving us a roadmap for the process and taxonomy for analyzing the nature of strategies. For now, we ought to focus on understanding the motivations driving strategy formation, mainly by focusing on who the players are and what their relationships are to the conflict.
2.2a Players of this Game
The most basic restatement of the framework thus stated is that players manifest goals and articulate appeals and the venues for displaying goals and appeals differ wildly depending on the motives of the actors. But just what makes a player in a negotiation? The answer is complicated, for players can be added to a game for instrumental purposes and their goals vary in bearing to other players, sometimes even existing as a mutual interest.
Not just China and the US have an interest in the revaluation issue, yet the conflict is often framed as a bilateral conflict. This contradiction exists for a reason: when a simple negotiation between two parties is rendered as a complex negotiation, there may be some pressure to use coalition building, both inside and outside of national lines.
To state that players are actors who have a vested interest in talking out the RMB conflict implies that a player can be one of the principal actors to the conflict (China and the US), and it is possible for apparently secondary actors to be conscripted into play. International organizations such as the IMF and WTO and third party countries such as the European Union, Japan, and Korea are good examples. However, because of the nature of the conflict—or at least how it is depicted in the literature—the greater portion of my focus will be on framing this conflict as one between China and America bilaterally.
2.2b Some Caveats
As with many models, this particular scope of the RMB conflict has its limitations. Specifically, there are three major limitations to rendering the RMB conflict as a game. First, there is the limitation of hypothetical scope. Rendering the Sino-American relationship as a game has its benefits. For one, compared to a purely descriptive scope, rendering conflict as a game offers a conceptual framework for hypothesizing the full extent of a conflict, based upon the interests of each actor involved in the conflict. However, the results of my study are part of a hypothetical case, and thus flatter than real world case studies.
Second, there is the limitation of asymmetrical information. This is a crucial limitation that requires our full attention if we are to derive any insights from our game. Asymmetrical information is defined as one actor having imperfect information as to the intentions of one or more actors. This can occur simultaneously on different levels as well. For instance, one could say that the case where President Obama must plan for negotiations over the RMB conflict.
This is a two-level game where each actor has imperfect information. Obama, as the center point, would be forced to decide whether congress would prefer to enter formal negotiations or continue with consultations, and decide the same about the Chinese representatives. Mind you, in negotiations the best practice is not to exploit ignorance by blindsiding a rival.
It seems to me that the best strategy is to exploit imperfect information by redefining the issue in terms useful to your cause. For instance, it would be in a Chinese negotiators advantage to exploit an ignorance on the timeline for implementing revaluation to their advantage, pushing for a much more gradual revaluation rather than the steep “down payment” revaluation demanded by Goldstein and Lardy’s three-step program (2008: ).
Third, and most critical of all, there is the limitation of the straw man. Although the framework of negotiation seems to conceive of the whole of a nation or institution considered a unitary player, in reality complex negotiation by definition is about a two-level game, as defined by Robert Putnam (1988) as a scope that views players dealing with conflict on the international level while simultaneously dealing with the consequences of their actions within the decision making structure.
With this in mind, it will be very useful to understand the political forces that have mobilized within each nation, but also to understand the different bearing each political force has on the decision making structure. With this issue, there are fractures between the legislature and the executive in the US, and between political elites and business elites in China. But with the majority of the arguments furthered by theorists, asserting the economic reforms ideal for long-term economic growth, it is difficult to segregate classes for a particular nation, and to understand whether the ideal is actually implementable.
A particular reform may have certain beneficiaries and certain victims, but within the economic literature, few document the classes that affect the implementation of the prescriptions. Yet, it is worth noting that this failing has a reason. Our understanding how Chinese decision makers are influenced by forces within the nation is crude at best given the opaqueness of the party-state: outside of public statements, we are not privy to policy debates that occur among the Chinese political elite.
Hence, while it is in my best interest as a research to understand negotiations as a two-level game, the limited information make it difficult to get a full, unbiased picture of domestic politics. Thus, within the established scope, there are some critical limitations. Examining a hypothetical negotiation process by nature is an act of self-delusion. Yet, if one is careful in one’s speculations, sketching out a hypothetical negotiation is a form of lateral thinking that can expose some of the blocks to successful implementation of RMB revaluation. One means of making a solid case is to assume that negotiations are always just a little bit unpredictable; awareness that gambits are simply a tentative arrangement allows one to fully comprehend the implications of analysis.
Finally, it is in our best interests to remember that the opinions voiced within the full body of academic literature represents only a small subset of the Chinese public, let alone those who have the political resources and will to influence the Chinese trade negotiation team.
2.2c Their Broad Goals
With China and the US as the principal players in the RMB conflict, it is worth defining their goals, as expressed by policymakers and intellectuals. China’s basic goals in the RMB conflict are as follows:
To understand the US model of growth, particularly for development into consumption-based growth
To calculate the value of the current RMB policy on development
To calculate the value of neoliberalization
As to monetary policy, appeal to the principle of national sovereignty
To argue that in the context of financial liberalization
……Revaluation alone is not sufficient to reverse the trade or balance of payments surplus…Revaluation must be done gradually
…Immediate capital account liberalization will probably be harmful
…That there is inadequate evidence that flexible exchange leads to faster capital account adjustment
…That the choice between exchange rate flexibility and fiscal policy effectiveness is one that ought to be reserved to national policymaking for the foreseeable future
To build an understanding between US policymakers via SED consultations
To further cultivate an understanding on the topic
To assert authority over matters related to exchange rate liberalization in East Asia, viz the policy of transition via gradualism
Some goals are completely in harmony with US goals. Orthodox economists for the most part seem to be determined to understand how to transition into consumption-based growth, and a certain population of this orthodoxy (read: New Keynesians) has given greater weight to the consumption issue in light of the 2008 global financial crises. Additionally, some economists—not necessarily heterodox ones—agree with the logical arguments put forth by Chinese economists. And certainly, policymakers want to build rapport. America’s goals apart from China’s are as follows:
To understand the optimal package of reforms necessary to revalue and float the RMB while accomplishing financial liberalization
To assert that the US has the moral high ground necessary to bring in the IMF and/or WTO or other nations into the conflictTo calculate the losses incurred by the trade and balance of payment imbalances
To appeal to the principle of optimal economic policy viz monetary policy (i.e. neoliberal development’s universal appeal)
To argue in the context of financial liberalization……Revaluation must occur ASAP, not gradually
…Revaluation plus other financial reforms can reverse the trade and balance of payment surplus
…The floating exchange rate is an economically optimal regime
…That monetary policy is preferable to fiscal policy to developed nations (neoliberal belief)
To assert (political) authority over judging economic malfeasance
To assert (intellectual) authority over neoliberal developmental policy
Non-principal actors have bearing on the situation in a variety of ways, but strategically their merit lies in the gambit of coalition building. By this token, each side of the table has its own international coalition from which to draw.
First, although the EU has many of the same goals (i.e. the EU also has a massive trade deficit with China) as the US in bringing suit against the China, the issue for one reason or another had less salience to EU policymakers up until the recent past.
One may also note that outcomes of diplomacy may well increase the salience of the issue to the EU. If China decides to diversify its exchange holdings, it may adopt the euro with increasing enthusiasm, thus bringing EU goals on the RMB conflict closer in line with US goals. Additionally, if the conflict breaks down into protectionism, there is also a chance the EU could get drawn into the economic melee. In sum, the EU is the most likely national addition if the US wished to make the issue multilateral.
Second, China too has allies, although there is greater political unsteadiness, all things being equal. Examining the literature, and there seems to only be a vague potential for cooperation among North East Asian nations, mostly relating to the (unlikely) possibility of founding an Asian Currency Unit or any other attempt to come together for monetary solidarity.
Third, the US may be able to recruit the IMF or WTO with the right amount of pressure. However, at the moment this seems like a difficult proposition, as IMF officials tend to prefer high-level consultation. WTO action is even less likely, as it need to resolve a major jurisdictional problem with the IMF before it could act on the matter.In sum, I have sketched out the contours for a framework for conceptualizing a hypothetical negotiation over Chinese currency revaluation and/or exchange rate reform. In any particular case, resolving the RMB conflict would involve actions taking place away from and at the bargaining table, actions expressing views within or against the rules of negotiation. The actors involved with the conflict are variable, and the myriad of views expressed are sometimes confliction and sometimes complementary. However, with our particular case, we must keep in mind the appropriate limitations.
3. RESOLVING PLAY
In the previous section, I detailed the complexities of the trade negotiation process, unlocking some key details of its emergent form. Even with this framework in mind, there is very little certain about how, or if, the RMB conflict will end. We do not yet know the actual intensity of debate that may ensue on this subject, nor do we know which policy options the US will take to pressure the Chinese into revaluing and floating the RMB. We do not even know whether Chinese policymakers will decide to solve this problem on their own.
It is in our best interest to capture the diverse amount of settings for debate and our uncertainty of the magnitude of the conflict that will be generated in the process.
Therefore, to forecast how the RMB conflict may be resolved in the future, I will hypothesize how negotiations will proceed on three potential levels, the particular debates that manifest in these particular levels, how each side approaches each debate in order to further their cause, and the conditions for or implications of escalating the debate.
I will discuss how the actors attempt to solve the conflict prior to formal negotiation (1) through three options: bilateral mediation, complete inaction, and unilateral policy. I will argue that China has an advantage at this level so long as it can prevent unilateral policy, and that perhaps is one of the most likely causes for escalation.During formal negotiation (2), each side will color the debate by launching many different strategies. The US will attempt to bring in allies and place the debate into a forum that favors its interests; it is in China’s interests, to aggressively employ whatever means possible to sidetrack debates, to appropriately argue that keeping policy in Beijing’s hands is to the mutual benefit of both nations, and to cautiously alert the world of the contradictions in America’s position.When negotiations have concluded and reaction policy starts to come into effect (3), the world will face an entirely new set of conditions.
I will argue that after failed negotiations each nation is constrained from committing to constructive actions. At this point, reactionary policies would probably seek to punish malfeasance, and may result in greater harm than help. It is in everybody’s interest to avoid this situation, but because nobody can guarantee that it will not occur, it becomes the lynchpin to China’s advantage in the second level.
3.1 Level One
Level one encompasses all actions that occur prior to formal negotiation. For that reason, we can assume that some of strategies applicable for this domain are being used today. Elaborating on the conditions facing each nation, it is notable that both sides tend to take RMB revaluation as a necessity, and that there are some key similarities on how they believe it should occur, namely how it should be figured into liberalization or economic change as a whole.
However, there is also a fair amount of evidence that there is ambivalence on each side, with the greater part being the battle in America among coalitions both domestically and internationally. For this reason, China will continue to have control over the issue if it can keep debate at this level, but escalation will be more likely if the trade imbalances sustain within the recessed global economy.
3.3.1 Conditions Prior to Formal Negotiations
To speak of conditions of this setting is to speak of a combination of consonance and dissidence, with the former being the consultative process occurring between the two sides, and the latter being the policy formation process occurring both as a result of consultation, but also in spite of consultation. How can it be that the consultative process is successful, yet its influence on reforms is limited at best?
Answering this question requires one to define the constituent parts of the consultative process. One part of the consultative process is the constructive debate between Chinese and American non-political elites. One piece of evidence of the dialectical gears turning at this level is Morris Goldstein and Nicholas Lardy’s Debating China’s Exchange Rate Policy (2008). Written to document the developments at a conference hosted by the Peterson Institute in Washington D.C. on October 19, 2007, this tome juxtaposes the opinions of American and Chinese intellectuals (e.g. Kenneth Rogoff and Fan Gang), political figures (e.g. Lawrence Summers and Wu Xiaoling), and business experts (e.g. Jonathan Andersen and Stephen S. Roach), with some arguing against the contention that an immediate revaluation is necessary, and some affirming it.
This conference is but one of forms of scholarly exchanges between experts in the field, and at least within the pages of the book it inspired, there is some hope that there is a middle ground on revaluation that is acceptable for all parties. With Goldstein and Lardy’s anthology in mind, one can assume that major academic conferences commence to figure out what combination of liberalizations are ideal for allowing exchange rate reform.Another, less visible part of the consultative process is mediation between top Chinese and American leaders. Mediation occurs through personal trips between high officials (read: the President, Secretaries of Treasury and State, the Premier, Vice Premier, State Councilors), private consultations, and bilateral forums for discussion, for instance, through the US-China Strategic and Economic Dialogue held biannually since 2006.
These venues are in stark contrast to meetings at IMF conferences and WTO ministerial meetings because they lead to less hard commitments and contractual agreements. Yet, these venues are greatly important for future negotiation. Although these meetings are relatively secretive and lack hard bargaining, it can be argued that they represent a major point of influence over a number of the reform process.
Mediation holds a special importance to hearing dispute resolution in Chinese society, and at high levels personal contact is a major attribute that politicians can bring to negotiation. Rapport should simply not be overlooked as a tool for building personal trust and successful negotiation (Lee and Hwee 2009: 67-70, 101-107, 150-167). I believe these consultations are useful for reinforcing the value of including exchange rate reform in the broader context of financial liberalization.
Despite continued discussions in academia and political forums, reforms have not occurred, and this has led to charges that while intending to gently suggest that reforms are in the best interest of the state, Washington has actually done nothing at all. Indeed, there is little proof that China has taken a major step in the direction of exchange rate modification, or financial liberalization for that matter.
One possible cause for this occurs due to a difference of interpretation of the meaning of reform. On the American side, we have rubrics of exchange rate reform like Morris Goldstein and Nicholas Lardy’s three-stage approach. This prescription occurs over three stages: first, an immediate 15% appreciation followed by yearly appreciations of similar magnitudes, coupled with widening the peg’s band for daily fluctuation by 1 to 1.5%, alongside financial liberalization and target fiscal policy; second, over the next three years, more appreciation of 6 to 8% a year, coupled with more broader reforms; third, four or six years following the second phase, a commitment to float the RMB with broad reforms (Goldstein and Lardy 2008: 53-54). On the Chinese side with politicos such as Wu Xiaobing, we merely have a commitment to eventual currency appreciation.
When Chinese CEOs agitate for RMB appreciation, as reported in a Bloomberg Report in March 24, 2010, even they show favoritism of gradual appreciation. The fact of the matter is that Goldstein and Lardy’s argument that a “down payment” of a major appreciation does not have any traction among most Chinese elites. It could be that they are still traumatized by the last speculative wave that occurred in the wake of exchange rate adjustment, they have not been sufficiently persuaded by American academics such as Goldstein and Lardy, but the true cause of varying opinion over the appreciation timeline—hence, the grounds for agreement over exchange rate reform—remains ground zero for dissonance among academics.
Another source of dissonance occurs between political factors responsible for negotiating with China on the RMB conflict. Whereas the executive branch has taken the strategy of biding its time and engaging in high-level mediation, congress has taken a more proactive approach in past years, including proposing seven bills from 2005 to 2010 (S. 295, HR 2942, S 1607, S 1677, S. 1254, H.R.2378 and S.3134) and circulating a petition dated calling for countervailing tariffs, audits of China against the Omnibus Trade and Competitiveness Act of 1988, and involvement of the IMF and WTO to oversee this case. The petition in question was dated March 24, 2010 and contained the signatures of 150 congressmen and women.
Dissonance on this issue between the legislature and the executive is only natural; after all, legislators are more accountable to constituents and lobbying groups such as the AFL-CIO, UAW, and the relatively nascent Fair Currency Coalition. Conflict between branches also occurred in the midst of the battle to pass Permanent Normal Trade Relations (PNTR), and the Clinton administration relied on strategic coalition building to minimize opposition when the bill came to vote in the House of Representatives as HR 4444 (Deveaux, Lawrence, Watkins 2006: 292-298). Needless to say, given the framework of the two-level game, the existence of a coalition with a competing set of negotiation tactics can harm the integrity of America’s bargaining strategy.
3.3.2 Scoring Points and Escalation
Given the conditions at this level, what strategies can players take to maximize their success? For America, their policymakers currently take the criterion for success in pushing for gainful reform with as little perceived coercion as possible. Linking reform to aid, as with the AFC, has damaged actors’ credibility in the past. Pushing for exchange rate adjustment to be conducted in bad faith would limit the nation’s ability to act on economic imbalances in the future. But where does that leave China’s goals?
Success for Chinese negotiators can be placed in the area where informal negotiation has most bearing on the end goals for the Chinese side. In other words, in order for China to score points in this round, they must do whatever it takes to keep their definition of RMB appreciation the most salient. By furthering the gradualist approach to currency exchange, the Chinese side manages to achieve a goal in word in common with the US but without the political risk involved with sudden appreciation. Any perceived loss of control on this issue may be interpreted as a loss of national sovereignty, and this is a blow the Party is unwilling to endure.
Additionally, this round is beneficial to Chinese negotiators because mediation, characterized by its flexibility of rules, allows them dictate the terms of debate. Whether their goal is to find a common ground between staying the course and the three-stage appreciation, or simply an attempt to defer action for as long as possible, remaining in the first stage of negotiation should be the main goal of Chinese negotiators at this time.
Yet, the threat of escalation is an interesting twist, for it can happen in one of two ways. There is the possibility of negotiation escalating into bilateral or multilateral formal negotiation—level two, and there is also the possibility that the executive branch will decide (or will be successfully compelled) to agree with congress’ logic and immediately impose a countervailing tariff—thereby escalating to level three. So long as Geithner and Obama keep mum about the exchange rate in the immediate aftermath of the SE&D, there is no real way to predict whether they will adapt the hardliner stance.
Assuredly, as the trade and current account move farther away from equilibrium, particularly in the context of the sustained high levels of unemployment, the pressure to take a hardened stance will begin to weigh on the executive. A level three escalation should not be ruled out entirely, and in that case it would be in Beijing’s interest to settle on the second best of formal negotiation. Chinese policy makers ought to continually observe the sentiments of the American public and their congressmen in order to anticipate a level three escalation.
As an additional note, it may be the case that China initiating an escalation to level two, ceteris peribus, benefits them. The first mover advantage may confer agenda setting powers they might not otherwise have, so in final estimation China would perform best by thinking strategically and believing that, when push comes to shove, engaging in formal negotiations may not be as onerous as they imply.
3.2 Level Two
Level two encompasses formal negotiations. Formal negotiations on this issue will probably occur through the impetus of an actor. The US will most likely make its case by bringing the EU onto its side, or by shaping the agenda to that of the IMF and/or WTO approved forms of good governance. Despite the logical weight of these arguments, multilateralism can jeopardize decisive action; multilateral litigation or arbitration can be a painstakingly slow process. Assuming a failure to set a bargaining range for RMB appreciation, China’s response should be to exploit the bureaucratic plod of the world stage to railroad the issue in order to buy time to implement reform unilaterally. By emphasizing that Chinese policy makers have the same interests as those expressed internationally, and then to suggest that the differences in opinion are unwarranted given America’s stake in the problem and its precedent to overreach into domestic economic issues.
China has the tools to succeed in the bargaining phase, provided it can keep American trade representatives at the table, or at the very least from advocating for sanctions or other reactionary protectionist policies.
3.2.1 Conditions During Formal Negotiations
Consistent to the framework proposed by Bazerman and others, it is difficult to forecast the emergent processes of negotiations on the RMB revaluation conflict. However, given the interests of the actors, there are two constancies that we can assume as probable in any given version of negotiation at this level.
First, to address negotiation options, having established RMB appreciation timetables to be the most sensitive and crucial area for debate, the best practice for reaching a compromise is by establishing a bargaining range for appreciation.
Second, to address negotiation forums, the US will rely on multilateralism, possibly as a means of escalation, to further their argument that China is a currency manipulator. Meanwhile, in the event of dissatisfaction with bargaining, China may take advantage of the weaknesses latent to this approach to negotiation. Although the greater portion of the argument is this section approaches the US and Chinese versions of the RMB appreciation policies as mutually exclusive, this is not necessarily the case. Compromise is possible, and the best way of doing that would be through arranging a bargaining range. Devereaux, Lawrence, and Watkins define the bargaining range as the buyer’s maximum subtracted from the seller’s maximum (2006: 20).
For the purposes of the RMB conflict, negotiators may bargain over a number of things that can be quantified using a bargaining range, including magnitude of appreciation, sustained years of currency appreciation, and so on. An example of the simplest formulation of negotiation of this style would be over the down payment appreciation, as per Goldstein and Lardy’s three step plan. There is not guarantee that this would work: if China is particularly inflexible about the notion of down payment, or simply adverse to allowing another nation to dictate the terms of its reforms, then negotiations will break down.
From here, each party would need to apply leverage to reach a resolution. One simple way to increase one’s position in formal negotiations is to bolster one’s ranks. As Jean Pisani-Ferry notes, this is certainly applicable for America’s position in this conflict. In the past, the EU has gotten a free ride off the efforts of US officials to bring China to task.
However, in consideration that the EU trade deficit is growing against China, especially in recent years, EU officials have begun to warm to the idea of proactively engaging China. Despite the conventional wisdom, the EU is capable of acting on the conflict: they do not actually fear the unintended consequences of revaluation and have a coordinated view on trade policy. In short, they now have willingness to accompany their capacity to act in tandem with the US (Goldstein and Lardy 2008: 268-278).
In addition to the EU, there is the IMF and WTO as contributors to making the issue multilateral. As mentioned previously, advocates of immediate action against China’s exchange rate regime (such as certain lobbyists and congressmen) are interested in getting the IMF and/or the WTO involved in the debate. With trade issues, multilateralism has its benefits, and American policy makers understand this.
Under the GATT/WTO system, multilateralism as a platform for liberalization is one that is highly resilient in the face of stiff political opposition. For one, it allows for great salience for the losers of reform, possibly leading to compensatory action More commonly, however, multilateralism is a great enabler for reforms because of how it locks nations into change, allowing political agents to focus protesters’ attention to it instead of themselves (Stern 2009: 172-175). A major benefit of multilateralism that is most relevant to this issue is that it allows for greater consistency of the norms and rules brought into play.
Bringing the RMB conflict to the IMF and/or WTO reframes the conflict in a manner that confers advantage to the US. Unlike the mediation phase of negotiation, bargaining within the framework of something like the WTO Dispute Settlement Body (DSB) gives both parties access to a less malleable negotiation system, forcing each to hold fast to their commitments, and effectively jeopardizing China’s strategy of deferment.
Unfortunately, there is also a major downside to the multilateral approach. Because multilateralism by definition involves many actors engaging in many rounds of negotiation, it is not the most effective platform for demanding decisive action. While it may be true that each party involved may have similar interests on the issue, this is no guarantee for timely performance. One articulation of this point is that the US has not employed the WTO to litigate China because there is a jurisdictional debate—there has been no precedent of the WTO intervening on currency issues.
Because this conflict occurs between two intensely bureaucrat organizations, it is safe to say that this jurisdictional conflict will not be solved without the passage of time or external pressure from US stakeholders.In fact, placing negotiation into a multilateral arena gives China an opening to delay even more effectively. If Chinese policy makers choose to do so, it could agitate for the inclusion of Japan, another economy that runs on an undervalued currency.
Either through coordinated effort or simply by virtue of expanded interests, China would exploit this situation by means of toxic issues, red herring subjects, and other gambits that would delay the process. In particular, the WTO DSB is an example of the inefficiency of multilateral bodies in resolving disputes. Unfortunately, the DSB’s record speaks for itself: as of 1998, a paltry nine of two hundred cases has successfully passed through every stage specified in the Dispute Settlement Understanding. Besides moving to delay action in a multilateral venue, China can also use multilateralism to minimize America’s claim over the issue through ways.
First, Chinese policy makers can argue that they ought to have first say over how reforms should take place. Chinese experts tend to argue this very thing through the “balance-of-payments approach to the monetary accounts” approach. Needless to say, between the two nations there is at least some ambivalence as to the full implications of the currency misalignment, and Chinese negotiators could exploit it.
Second, China could use multilateralism, a venue of greater salience, to agitate against the contradictions in the US’s reform agenda. Two possible means of accomplishing this include, first, an appeal to the importance of national sovereignty—an issue not unknown to cautious IMF technocrats.
Second, and more persuasive, China could use an appeal to the problems of the dollar as a reserve currency. Arguing against the dollar is an effective way to gain the developing world on your side, particularly within East Asia. Populated by countries with a flummoxing combination of undeveloped financial markets and yet held to the dollar standard, East Asian debtor nations facing “original sin” are sensitive to the demand that East Asian nations need to float their currencies, for they dealt with the insurmountable risk of currency mismatch compounded by maturity mismatch when they experimented with a float. Creditor nations in this position also suffer the problems of the float in addition to balance of payments imbalances.
In a particular point of view, their syndrome of “conflicted virtue” makes it difficult for them to appreciate their national currency to truly rid themselves of dollars or rectify the Americans’ reluctance to save. Yet, appreciation will definitely lead to deflationary spirals (McKinnon 2005: 5-14, 239-244). China could very easily draw from the paranoia of developing nations on this topic. Broaching this subject allows China to frame moves such as proposing a new world currency standard as opposing a negligent hegemonic power. Although implementing IMF special drawing rights as the world reserve currency is no easy task, it does issue a challenge to America that may offer significant leverage in the context of a second level negotiation.
3.2.2 Scoring Points and Escalation
Previously, I have established I have established that multilateralism is a double-edged blade in the advancement of US interests in the second level of debates. Yet, I have not explained how this affects the overall strategy of both sides of the RMB conflict. For America, it creates a very difficult choice for how to proceed. Multilateralism has had a mixed record, especially with an eye to solving disputes between the US and China.
With this in mind, it may be a good idea for China to suggest multilateralism when the threat of level two negotiation occurs, for policy makers could easily demonstrate that Japan ought to be included and from there railroad the proceedings. For America, a good strategy with consideration of the efficiency problems of multilateralism, is to consider “priming” a venue before starting negotiations. The US during the first stage generally has the incentive to bring the case to China, so it certainly has a window to prepare for negotiations. For multilateral organizations in particular, there are some specific ways to prepare for intense negotiation.
One possible way to do this is to get non-governmental organizations to do the heavy lifting viz framing an argument. Bringing in the UAW, AFL-CIO, USW, and other key constituents of the exchange range adjustment would allow for the construction of a compelling narrative. Finally, these NGOs could also be handy for consultation as to how the US could “sweeten” the deal with key concessions made to spare the workers who might be affected by the sudden deflation. Such a balanced approach would effectively undermine the framing techniques Beijing would attempt to use. The costs for outright dissension rise in a second level game, so it would be unwise for Beijing to consider ending the policy of delaying as end all strategy.
Instead, for this round they should attempt to keep the bargainers at the bargaining table as long as possible, regardless of the concessions, for at this stage, China should believe that avoiding escalation is probably more important than avoiding assenting to America.Escalation in this issue, at least in the view of many, is tantamount to the nuclear option, and Lawrence Summers even acknowledges this by referring to the escalation into protectionism each side offers to be a form of “balance of terror”.
However, there is a certain consideration that may paint our understanding of how escalation into level three would occur: timing. To wit, at what point do we consider it likely for the opposing party to react to protectionist policy—would it be as congress is finalizing the bill or as the bill came into service? Ultimately, this gives leeway for the nuclear option to be used as a bluff. A strong offensive strategy, in other words, may be the right amount of external pressure to force a last-minute concession from Beijing. However, we must also keep in mind that such a reform would obviously be made in bad faith—there is no guarantee that one instance of assent would imply China would not renege on its promise.
3.3. Level Three
Level three encompasses the policy aftermath of failed negotiations. This level represents the Rubicon crossing point when political elites of both countries consider harder ways to bring about change, comprised of tariffs, economic sanctions, and other protectionist policies. Although there is a contingent that believes that sanctions would be to America’s benefit, I will argue that the political fallout from this event will probably be far more painful than the reform it might inspire. The only palatable way for the US to act in this domain, in my opinion, is as a bluff to inspire last minute concession, but even this technique is dubious at best.
3.3.1 The Endgame?
In the context of currency revaluation, protectionism does not necessarily lead to further conflict, owing to the continuum of protectionist policies. For the cases in question, let us assume that the US’s reactionary unilateral policy, in line with 2005’s US bill S. 295 would impose a countervailing duty of 27.5 percent on all Chinese goods. Would this action alone be enough to trigger sufficient backlash to create a real disincentive against protectionism? Robert E. Scott and Paul Krugman argue that American policy makers should has nothing to fear in being hardnosed in the face of Chinese currency misalignment. Krugman argues that a currency sell off would not affect interest rates, and that the resultant depreciation ought to give our export an advantage in the world markets, and also reminds readers that temporary duties placed on West Germany and Japan in 1971 gave them the necessary pressure to revalue their currencies. Scott adds that even if one act of protectionism gave impetus for protectionism internationally, the most likely situation would be rampant protectionism against China, possibly culminating into a multilateral response to exchange misalignments.
Yet, in my mind, this is an oversimplification of the nature of protectionism and economic warfare. For one, these views tend to underestimate the demonstrative effects of protectionism. As the GAO’s study in 2006 argues, countervailing duties are hard to effectively apply (a) without being accompanied by antidumping tariffs and (b) information about subsidization in China is incomplete, so double counting would be almost guaranteed (GAO 2006: 14-18).
Second, and more importantly, Krugman and Scott underestimate the negative externalities from protectionism. Namely, they conveniently ignore the potential that this economic conflict could perpetuate itself in political conflict. This outcome is hard to predict but should not be ignored. Taking the second point further, one finds that although China’s strategies following unilateral protectionism becomes suitably zero sum—that is, shape up or shape out—there absolutely will be freedom to act after this initial decision.
In other words, for American, escalating to the brink comes with some form of medium-run political costs. Such is the surcharge America pays for having unprecedented amount of oversight in the exchange rate regimes of nations around the world.
In this section, I have discussed how the RMB revaluation issue might unfold and some strategies for China in the three varying levels of escalation. First, prior to formal negotiation, China ought to do its best to defer formal negotiations. The only path to formal negotiations with assured success is in anticipation of sanctions.Second, in formal negotiations, it is in China’s interest to keep America at the bargaining table, and one possible means is by conjuring delays in a multilateral forum. However, assent should always be place at a higher priority than escalation. With the third level, countervailing duties are imposed on China. At this point, “the only winning move is not to play.”
Talking about the possible negotiations that would transpire in reaction to the RMB conflict solicited some interesting conclusions. First, on the topic of the historical contingency of China’s reforms, I found that inflationary cycles triggered by undisciplined fiscal policy led to the implementation of a pegged exchange rate. The continual purchases of dollar reserves is a natural outcome of this ad hoc system, but in recent years it has become increasingly unstable and the dominant economic theories suggest that it will soon reach critical mass viz the sterilization process.
Second, sketching a framework for understanding how negotiation on the RMB conflict would occur emphasizes the fluidity of gambits. Bargaining is an emergent process, one that evolves away from the table and at the table. Additionally, the limitations of hypothesizing the strategies employed in bargaining are clear: the resulting research may be able to conjecture on how players’ interests are represented and exploited, the analysis is cannot be well-grounded in empirical data, it cannot accurately represent a possible sequencing of bargaining strategies, and it reflects an bias on intellectual elites.
Finally, in analyzing a three level representation of negotiations, I find that it is in China’s interest to at first keep away from the bargaining table. When finally brought to the bargaining table, Chinese negotiators ought to do whatever possible to keep America at the bargaining table. We bring China to task on this issue because we believe we can stimulate their policymakers to enact good policy. Hence, we manipulate the flows of currency, purportedly adhering to the policy of mutual benefit.
Ultimately, I think that if this were really true, logic would be sufficient to convince Chinese economists to agitate for change, independent from American political power. But because today money is worth more than ever, I sincerely doubt we will be able to adhere to the articles of faith to let Chinese policymakers independently construct their nation’s exchange rate regime.
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