Financial Times Report on Ben Bernake's Remark

Bernanke calls for renminbi revaluation

By Krishna Guha in Beijing Published: December 15 2006 06:06 | Last updated: December 15 2006 09:11

Ben Bernanke, chairman of US Federal Reserve, stepped into a political minefield on Friday when he released remarks branding China’s undervalued currency an “effective subsidy” for its exporters which was distorting patterns of production and trade. In what looked to be a last minute bid to avoid controversy, Mr Bernanke then dropped the phrase from his speech to the Chinese Academy of Social sciences, using the less inflammatory term “distortion” instead.

Mr Bernanke’s original text talked about “the effective subsidy that an undervalued currency provides for Chinese firms that focus on exporting rather than producing for the domestic market.” This phrase – even though not finally uttered by the Fed chief – is likely to be seized on by US manufacturers who have long pressed US government agencies to make the same determination in trade cases.

A Fed spokeswoman said Mr Bernanke’s decision to drop the word “subsidy” was “a spontaneous decision” aimed at enhancing the clarity of his remarks. She said the Fed had not been asked to drop the term by anyone in the US administration delegation in Beijing for the final day of the high-level strategic economic dialogue.

The Fed is standing by the language of the original text, which is posted on its website, and has not repudiated the view that the currency regime does amount to an “effective subsidy.”

As in the prepared text, Mr Bernanke called on China to embrace “further appreciation of the renminbi, combined with a wider trading band and with the ultimate goal of a market-determined exchange rate.”

He said this would “allow an effective and independent monetary policy” that would help promote “growth and stability.” The Fed chairman’s references to the currency were made in the context of a measured speech, in which he said that while currency appreciation would be “helpful”, the “most direct and probably the most effective way to reduce the external surpluses and increase the welfare of Chinese households” would be to reduce the incentive for households to save by improving the social safety net.

However, he insisted that a more flexible exchange rate was in China’s own national interest. Mr Bernanke said the ever-increasing amount of sterilisation bonds needed to mop up excess reserves would crowd out other financial assets.

But he suggested that the bigger danger is that China is channeling investment into export industries “whose economic viability depends on undervaluation of the exchange rate.” These projects could turn bad if and when the currency does appreciate, resulting in “an increase in non-performing loans.” In order for China to “enjoy the fruits of its growth” it would be necessary for the economy to shift more resources towards production for domestic consumption rather than export and investment.

“To create incentives for this you are going to need real effective exchange rate adjustment,” he said. Elsewere in his speech, Mr Bernanke warned that continued high levels of investment in industries such as steel which already showed “signs of excess capacity” suggested “capital misallocation” was currently taking place. He said greater competition in the financial sector would result in more efficient pricing of risks and “reduce the risk that uneconomic investments could exacerbate the problem of non-performing loans.”

Mr Bernanke said this misallocation of capital – “the result of an undervalued exchange rate and of capital markets that…remain distorted and underdeveloped” – was the “principal risk” to China’s prospects, and could lead to “slower growth and future financial stress.”