As a presidential candidate, Barack Obama pledged to press China hard to stop manipulating its currency. His Treasury secretary, Timothy Geithner, said during confirmation hearings that he thought China was guilty of manipulation.
Yet last week, for the third time since Obama and Geithner took office, they stopped short of calling China a currency manipulator. Instead, a Treasury report praised China's recent decision to let the yuan float upward, while emphasizing that the Chinese currency remains undervalued.
The report was greeted by a predictable chorus of criticism from industrialists and members of Congress who favored harsher action. Some threatened to push for legislation that would punish China.
The Obama administration's kinder, gentler approach needs time to work, however. The yuan has appreciated about 1 percent against the dollar since June 19, when China relaxed its currency peg for the first time in two years.
That isn't much, but it's a start. Before the onset of the global recession, when China put the brakes on its currency for fear of losing export markets, the yuan had risen 21 percent in three years.
Philip Levy, a resident scholar at the American Enterprise Institute, said his best guess was that the yuan would again appreciate by 6 to 7 percent a year. That will depend on many factors, including the health of China's own economy and conditions in Europe, China's biggest export market.
"If everything stays normal, you'll get a slow and steady appreciation, but they're not wedded to it," Levy said.
Many firms in China's export-oriented economy operate on thin profit margins, Levy said. "If you have a big number of firms with 3 percent profit margins and you do a 5 percent appreciation of the currency, you could wipe them out," he added. "Their nightmare scenario is 5 million unemployed workers sitting around southern China talking to each other on their cell phones about how dissatisfied they are."
Morris Goldstein, a senior fellow at the Peterson Institute for International Economics, estimates that the yuan is undervalued by between 10 and 20 percent. That's far below the 40 percent figure he and others were citing a few years ago, but it's still enough to put U.S. manufacturers at a disadvantage.
Goldstein has advocated putting more pressure on the Chinese, and he thinks the day may yet come when the U.S. formally applies the currency-manipulator label. A 1988 law requires the Treasury to assess currency markets twice a year and to begin official consultations with any country that's guilty of manipulation.
"There is a set of circumstances under which I think they might pull the trigger, but it's going to have to be much worse than it is now," Goldstein said. "A year from now, if China hasn't moved much, then maybe."
The Chinese have their own reasons for wanting a higher exchange rate — for one thing, it will ward off inflation — but they don't want to be seen as buckling under international pressure. At the recent G-20 summit meeting, China didn't even want any official language praising its new currency policy.
"These are decisions that mix economics and politics in a very complicated way," says James Little, a business professor at Washington University. "They clearly don't want to be seen as having been pushed into anything."
For now, then, the Obama administration's speak-softly approach appears to be the right one. It will be interesting to see if Geithner turns up the rhetoric in the next currency report, which is due just before this fall's congressional elections.
