The US and others seem to believe that China’s currency is the biggest obstacle to the global recovery.
That is highly debatable, as I argued on VoxEU.
In any case, the Chinese renminbi is up 3.1% against the dollar over the past 12 months.
And since inflation is 4.4% in China and only 1.1% in the US, in real terms it is up 6.4%.
Would a faster appreciation really do more good than harm?
Economies cannot adjust painlessly overnight.
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.
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?”, VoxEU.org, 23 October.
Bergsten, C Fred (2010), “China’s currency and the US economy”, VoxEU.org, 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”, VoxEU.org, 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”, VoxEU.org, 19 October.
I debated the future of the euro with Josef Joffe, the editor of Die Zeit, on the Riz Khan show on Al Jazeera English on 20 May 2010.
“Fears grow about weaker euro” is the headline in today’s FT.
But what’s to fear?
For a start, the euro is hardly “weak”. It is back to where it was 18 months ago and is still much stronger than it was, for instance, in 2002, when it was worth less than 90 US cents.
But more importantly, a weaker currency is just what the eurozone needs.
It will make exports more competitive, and hence boost growth.
It will stave off exaggerated fears about deflation. (Spanish prices fell by 0.1% last month).
And it will boost its peripheral economies that are introducing savage austerity measures to pacify the markets – Greece, Portugal, Ireland and Spain – in particular.
Above all, what this fuss shows is that panicky investors are determined to see everything in a negative light.
They worry when the euro goes up, and they worry when it goes down.
While the first fear is justified, the second is not.
Ken Clarke and the Tories are trying to scare people by claiming that a hung parliament would cause a crisis in the markets that could push Britain into the hands of the IMF.
Yet as Cleggmania has swept Britain this week, the pound has strengthened against the euro every day, as this graph from FT.com shows.
Excellent article by Avinash Persaud on Vox
Highlights:
The notion that the world was suffering from a savings glut, that would have pulled us all into recession were it not for America’s selfless consumption, is also as deficient in arithmetic as it is self-serving.
You cannot save yourself into boom… But all it would take to deliver precisely the kind of boom-bust cycle we did live through would be loose fiscal, monetary and regulatory policy in the US and elsewhere, fueling a consumption boom in the world’s largest economy that would necessarily lead to surpluses in a swathe of consumer goods and commodity exporters, irrespective of their currency regime, like Germany and Chile.
We have been here before. Back in the mid-1980s, Detroit blamed its woes not on the inferior quality of American cars, their gas guzzling, or the fact that the Japanese prefer not to carry all their belongings in the back or to have the steering wheel on the left. They blamed the yen-dollar exchange rate.
Political pressure pushed the yen up by more than the 27% being sought today by the US Congress for the yuan. It did as little to save Detroit then as a rise in the yuan would do today.
China’s exchange rate has far more to do with national politics than international economics, which is one of the reasons why the US Treasury’s assessment of whether China is guilty of currency manipulation may be postponed as a quid pro quo for progress in areas of mutual diplomatic concern between the two countries.
This is a more technical post.
When financial panic spread even to sound emerging economies after Lehman collapsed in September 2008, the Fed responded by extending swap lines to central banks in Brazil, Korea, Mexico and Singapore, while the ECB provided them to Hungary and Poland. These unprecedented moves played a key role in quelling the panic.
The four emerging economies that the Fed helped were all well-run, but a new paper suggests that “the exposure of US banks was the single most important explanation for why the US selected to swap deals with the ‘chosen four’, as a summary on Vox explains.
Might such swap lines substitute for the vast foreign-exchange reserves that many emerging economies have felt compelled to accumulate?
Only to a limited extent, the paper concludes:
there are clear limits to substitutability between swaps and reserves. By and large swap lines are extended only to fundamentally sound and well-managed emerging markets, and to important trade partners. Crucially, sound fundamentals include healthy levels of foreign-exchange reserves. The highly selective nature of swap recipients means that a majority of developing countries will not have access to swap facilities. While swaps can contribute to the global public good of global financial stability, in fact large central banks provide liquidity support only when it is in the self-interest of their respective countries to do so. The inclusion of countries such as Argentina and Belarus – not known for strong fundamentals or sound management – among the Bank of China’s swap recipient countries points to the overarching dominance of export markets as the key criterion. Following from this, the growth of yuan-dominated swap lines may be a precursor to the eventual emergence of the yuan as a new reserve currency.
When market confidence is shattered, foreign-exchange market intervention to stabilise exchange rate becomes ineffective, even if the economy has sound fundamentals. That is, reserves fail to perform their precautionary or self-insurance function when the unlikely becomes the reality. In fact, in the case of Korea, declining reserves themselves intensified market fears and concerns, forming a vicious cycle in which adverse market sentiment drives down reserves via foreign-exchange market intervention, and the decline in reserves, in turn, further dampens market sentiment. The timing of market movements suggests that the Bank of Korea’s three swap agreements, in particular the agreement with the US Fed, played a pivotal role in calming down the growing market hysteria over a possible dollar shortage.
Taxes on capital inflows might provide a better alternative, the authors suggest.
since financial instability in emerging markets is usually the result of volatile capital flows and the fundamental purpose of precautionary reserves is to limit financial instability, some emerging markets may opt to dampen the precautionary accumulation of foreign-exchange reserves by controlling volatile capital flows. According to this argument, controlled financial integration, which retains some restrictions on capital flows, may limit financial instability. This, in turn, will limit the need for precautionary foreign-exchange reserves.
One possible solution to sudden stops and de-leveraging may be a Pigovian tax scheme, where inflows of portfolio flows and external borrowing above a threshold may be taxed at an increasing rate, reflecting the resultant higher exposure of the central bank to possible future bailout of the banking system.2 Such a tax scheme, implemented before the inflow of foreign funds takes place, may curtail exposure to the growing hazard facing the recipient country due to possible de leveraging (see Aizenman 2009). It may induce the foreign investor to internalise the externality associated with possible costs of de-leveraging, and would reduce the cost of self insurance.
Amid all the euro-phobes' schadenfreude about the euro-zone's travails, it is remarkable that the pound is plunging – not just against the US dollar, but also against the much-maligned euro.
If markets get panicky about the UK government's deficits, we may regret our not-so-splendid isolation from the euro-zone.