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Countless column inches are devoted to the supposed wickedness of China’s currency policy (Bergsten 2010, Krugman 2010, Wolf 2010, Yiping 2010). But the biggest threat to the world economy comes from the US. Its policy mix – fiscally passive, monetarily aggressive – is ineffective domestically and dangerous for everyone.

Seen from Washington or London, the economy remains weak. But from a global perspective, it is advancing by some 4% a year – almost as fast as before the crisis. China and other emerging economies account for the bulk of this growth. In effect, Chinese investment has taken over from US consumption as the locomotive of global growth (Reisen 2010).

Yet because it has a current-account surplus, China is widely perceived to be a drag on the global economy. This is misleadingly simplistic.

  • Its imports grew by 24% in the 12 months to September, creating jobs and growth elsewhere.
  • Its trade surplus is shrinking.
  • And, lest critics forget, even Chinese exports have their benefits. Assembled from parts made in other countries, they provide cheap inputs for businesses everywhere. They spur companies outside China to innovate and become more competitive. And they increase consumers’ welfare – why else would people buy them?

Basing conclusions on accounting identities can obscure the more complex, dynamic economic relationships that underlie them (Legrain 2010).

Put simply, if China were to vanish overnight, the world would be in much worse shape. And while it may be desirable for China’s currency to appreciate gradually to accommodate and accelerate a shift towards higher-end production and greater domestic consumption, a higher renminbi is unlikely to do wonders for the US economy (Auerbach and Obstfeld 2010).

For the most part, the alternative to cheap Chinese imports is not goods “made in the USA” but goods made in other emerging economies. Reshaping the US economy to cater more to the needs of emerging economies would do far more to boost US exports. Above all, trying to force the renminbi up with protectionist threats – as the US Congress demands and many respectable and ostensibly liberal commentators now seem to advocate – is to invite a trade war that would beggar us all.

Instead of threatening others, the US should put its own house in order. The Federal Reserve helped cause the mess we are in and is now sowing the seeds for the next crisis. Having wrecked the US economy by encouraging a huge debt-fuelled bubble to inflate, the Fed now finds itself unable to ensure recovery. Even with near-zero interest rates, indebted consumers don’t want to borrow and fragile banks don’t want to lend. Businesses that could generate growth are either starved of credit or too uncertain about the future to invest. As the Fed pumps out ever more money, banks invest it in higher-yielding Treasuries, pocketing easy profits and paying out ill-deserved bonuses, while much of it leaks out overseas. The net result? Hardly any additional US growth.

Since the monetary transmission mechanism is broken, injecting ever more money into the system does not get the wheels of the economy spinning faster. It floods the engine. A better way to stimulate the US economy would be fiscal measures that promote its restructuring and enhance its productive potential – for instance, investment in its dilapidated infrastructure, cuts in payroll tax and retraining subsidies to get people into work and, in the absence of a carbon tax, measures to promote venture capital in the clean-tech industries of the future.

Current US policy is not just ineffectual, it is also dangerous. Banks that ought to fold are kept on life support. Homeowners who ought to default and move to where the jobs are cling on to their depreciated houses in depressed areas. Bubble-prone investors believe in a Bernanke put. Money gushes out of the US and into emerging economies that don’t need it and can’t cope with it. This is economic vandalism.

The strategic rationale for printing money – sorry, “quantitative easing” – may be to force Beijing’s hand on the renminbi. Yet protected by capital controls, adept at sterilising monetary inflows and loath to give in to US pressure, China is unlikely to move much. Carrots – such as a bigger role at the IMF and the opportunity to convert some of its dollar reserves into special drawing rights (SDRs) – might work better than sticks. The victims are instead the Eurozone, Japan, Australia and other advanced economies whose currencies are soaring, as well as emerging economies such as Brazil and Thailand that cannot do much to stem the tide of US cash.

Do Barack Obama and Ben Bernanke really want a repeat of the 1997/98 Asian financial crisis, this time writ-large across emerging economies that account for half the world economy and most of its growth potential? Do they want to pick up the pieces for US investors and financial institutions? Do they not worry that investors might eventually lose all confidence in the devalued dollar and depreciated not-so-safe US Treasuries? Or are they so narrowly focused on the here and now, so blind to alternative policies, and so reckless in abusing American monetary power that they don’t care?


Auerbach, Alan J and Obstfeld, Maurice (2010), “Too much focus on the yuan?”,, 23 October.
Bergsten, C Fred (2010), “China’s currency and the US economy”,, 1 November.
Krugman, Paul (2010), “Taking on China”, New York Times, 1 October.
Legrain, Philippe (2010), Aftershock: Reshaping the World Economy After the Crisis.
Reisen, Helmut (2010), “Global imbalances, the renminbi, and poor-country growth”,, 1 November.
Wolf, Martin (2010), “How to fight the currency wars with stubborn China?”, Financial Times, 5 October.
Yiping, Huang (2010), “A currency war the US cannot win”,, 19 October.

Posted 03 Nov 2010 in Published articles

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