Geithner Calls for Rate Flexibility; China Ducks Yuan Issue

NANJING, China—In a thinly veiled criticism of China's currency policy, U.S. Treasury Secretary Timothy Geithner argued forcefully for flexible exchange rates at the start of an international financial summit in the Chinese city of Nanjing on Thursday, where Beijing had tried to avoid discussion of its handling of the yuan.

Mr. Geithner didn't specifically name China's currency in remarks prepared for delivery at the Nanjing forum, but his comments were clearly aimed at least in part at Beijing, which closely manages the yuan's exchange rate. He characterized the mismatch between fixed and floating exchange rates as "the most important problem to solve in the international monetary system today," and he said flexible exchange rates can help countries better absorb shocks and better tailor monetary policies to their individual circumstances.

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U.S. Treasury Secretary Timothy Geithner and China Vice Premier Wang Qishan, here Thursday, both delivered exchange-rate speeches without mentioning the yuan.
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The U.S. treasury secretary's remarks—on one of the thorniest issues between the world's two biggest economies—highlighted sharp differences that threaten to overshadow the Nanjing seminar and its efforts to explore changes to the international monetary system. China reluctantly agreed to French President Nicolas Sarkozy's request to co-host the Nanjing meeting—a hybrid between an official meeting of the Group of 20 industrial and developing nations and an academic seminar—and Beijing has insisted that the yuan exchange rate isn't up for discussion.

The U.S. and other governments have long complained that China unfairly keeps the yuan undervalued to benefit its exporters, and asserted that the policy aggravates global trade and capital imbalances. China ended the yuan's de facto peg to the U.S. dollar in June but has allowed it to gain just over 4% against the U.S. currency since then.

Beijing counters that U.S. policy—in particular the Federal Reserve's practice of buying Treasury debt to try to keep interest rates down, known as quantitative easing—has weakened the dollar and sent big capital flows into emerging markets that are fueling inflation.

Chinese officials speaking at Thursday's conference avoided addressing the currency issue directly, opting instead for relatively vague calls for gradual change to the global system.

Vice Premier Wang Qishan, the top Chinese official at the gathering, said Beijing will work with others toward "a more equitable global monetary system." He said global liquidity "is still too ample" and that improving the international monetary system will help prevent volatility in exchange rates and commodity prices.

Mr. Wang noted that the earthquake in Japan has added to global economic uncertainties, and that the sovereign debt crisis in Europe remains serious. He said China will stimulate domestic demand over the next five years as part of efforts to make the world's second-largest economy less dependent on exports and government investments.

However, just ahead of Thursday's meeting, a prominent Chinese government academic fired his own volley in the currency debate, criticizing the dollar's global dominance as well as the U.S. Federal Reserve's monetary policy, saying they are the "significant problems" in the international monetary system.

Xu Hongcai, a professor at the China Center for International Economic Exchanges, a state-run think tank, said dollar dominance has caused irregular flows of global capital and abnormal exchange-rate fluctuations, and said one solution to the problem would be to set up a system of multiple international reserve currencies. Mr. Xu's article was posted this week on the website of the China Center for International Economic Exchanges, which is a co-organizer of the Nanjing gathering.

"In order to deal with the impact of international speculative capital, developing countries were forced to accumulate large amounts of foreign reserves to use real resources to get U.S. dollar notes and then buy U.S. Treasurys. However, returns on purchase of U.S. Treasurys are very low and developing countries face risks of capital depreciation," Mr. Xu wrote. He said the dollar's dominance worsened financial crises in the past, and he also blamed the Fed's monetary policy for the dollar's depreciation, excess global liquidity and inflation.

Opening the meeting with Mr. Wang on Thursday, Mr. Sarkozy also said the accumulation of currency reserves is costly and the world needs to move toward more flexible exchange regimes.

Mr. Geithner noted that while most major emerging economies "now operate largely flexible exchange rate regimes" with open capital accounts, "some emerging markets run tightly managed exchange-rate regimes with very extensive capital controls," though he noted "this is starting to change."

"This asymmetry in exchange-rate policies creates a lot of tension," the treasury secretary said. "It magnifies upward pressure on those emerging-market exchange rates that are allowed to move and where capital accounts are much more open. It intensifies inflation risk in those emerging economies with undervalued exchange rates. And, finally, it generates protectionist pressures."

Mr. Geithner said the International Monetary Fund should be given greater freedom to publish its analysis of countries' exchange rates and imbalances. He said the U.S. supports changing the composition of Special Drawing Rights, a kind of synthetic reserve currency created by the IMF and based on a basket of major currencies, arguing that "currencies of large economies heavily used in international trade and financial transactions should become part of the SDR basket."

At the G-20, discussion has centered around expanding the use of SDRs generally, as well as eventually including the yuan into the SDR basket. Mr. Geithner, however, listed conditions for a currency to join the SDR basket that would make yuan inclusion impossible without deep reforms.

For their currencies to be included, countries should have "flexible exchange-rate systems, independent central banks, and permit the free movement of capital flows," Mr. Geithner said.

China currently is far from meeting any of those criteria. While policymakers have talked about gradually boosting the flexibility of the yuan's exchange rate and opening up further to international capital flows, it is difficult to see how a legitimately independent central bank could be established in the country that is still governed by a Communist Party leadership that insists on ultimate control of the economy. All major policy decisions by the central bank require the approval of the country's top leadership.

Earlier Thursday, another prominent Chinese economist and central bank adviser said reform of the international monetary system should be carried out gradually so as to minimize the negative impact on China's massive foreign-exchange reserves.

Speaking on the sidelines of the Nanjing gathering, Li Daokui, an economist and adviser to the People's Bank of China, said it would be extremely undesirable to see the dollar or U.S. debt undergo rapid devaluation. Mr. Li also said it is necessary to further boost the role of SDRs, and expand the use and the number of components in the synthetic currency. But he said the international community shouldn't link China's push toward the yuan's eventual convertibility to the reform of SDRs.

--Dinny McMahon and Lily Sun in Nanjing and Liu Li in Beijing contributed to this report.

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