Global Economy

Thought of the day: China’s currency

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.

America’s economic policy mix is a threat to the world

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?

References

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.

Why Paul Krugman is wrong

In his blog post, Dealing with Chermany, Paul Krugman advocates threatening China (and, indirectly, Germany) with an anti-dumping duty to get them to boost domestic demand.

China has done nothing to change its policy of massive currency manipulation...  Europe is going wild for fiscal austerity… everyone is counting on the US to become the consumer of last resort, sucking in imports thanks to a weak euro and a manipulated renminbi. Oh, and while they rely on US demand to make up for their own contractionary policies, they’ll lecture us on how irresponsible we’re being, running those budget and current account deficits.

This is not going to work — and the United States has to take steps to protect itself….

Nicely, nicely isn’t working. Time to get tough.

Yet his proposal would make matters far worse. This is my reply:

You are forever warning politicians to avoid the mistakes of the 1930s in macroeconomic policy and yet in the same breath you advocate that America should threaten Europe and China with protectionism. This risks far more than a “diplomatic tiff”: it could easily cause a tit-for-tat cycle of protectionism akin to that which caused global trade to collapse during the Depression years. Have you taken leave of your senses?

In the case of Europe, the notion that it is going “wild for fiscal austerity” because it is counting on American demand to save the day is blinkered and self-centred. Most European governments are being forced into austerity by the threat that markets will stop funding their deficits. The euro’s fall is hardly under their control either. America might be in a similar position were it not for the privileged – and deflationary – role of the US dollar in the international monetary system. Count your blessings that there isn’t a run on US Treasuries when America’s deficit and debt are higher than most EU countries’.

The main reason why the pattern of supply and demand in the global economy is so distorted is because of America’s unprecedented housing and financial bubble. You are right that now that the bubble has burst, surplus countries ought to do more to boost demand. But threatening protectionism is hardly the answer. And America should put its own house in order before lashing out at foreigners. The Fed’s monetary policy would be more effective if the banking system’s balance sheet had been cleaned up. Fiscal policy would be more effective if it was directed at investment in future growth – improving America’s crumbling infrastructure, for instance – and supporting the incomes of the poor, who by necessity are spenders rather than savers. It seems instead as if Ben Bernanke is intent on doing a Greenspan: inflating another bubble to rescue America from the previous bust. Don’t blame the rest of the world for that.

Ferraris for all

I had the pleasure of meeting Daniel Ben-Ami on Saturday and recommend you check out his blog and his book, Ferraris for All, which is out in July and makes the important case for economic progress, which too many people in the West have unfortunately lost confidence in.

As I argue in Aftershock, we should take inspiration from the optimism of people in emerging economies such as China, India and Brazil who know all too well that economic progress is real, and that it makes the world freer, fairer and more secure.

Chinese tourists now spend more than the French

Amid all the worries about cheap Chinese exports undercutting Western products and costing Americans and Europeans their jobs, people often forget that China’s explosive growth also creates huge new opportunities for Westerners.

A decade ago, Chinese tourists were rare birds. Now, they are the world’s fourth-biggest spenders. They spent $43.7 billion last year, 21% more than the previous year – more than the French. German tourists are the third-biggest spenders, Britons second and Americans first.

As Chinese tourists become as ubiquitous as the Japanese became in the 1980s, it will boost Western business and provide lots of new jobs.

Hat tip: ViewFlow.

Is the IMF’s proposed bank tax a good idea?

It is outrageous that governments bailed out failed banks. There were better alternatives. But given that mistake, it is understandable that governments – and taxpayers – want to get their money back.

The IMF has therefore proposed that G20 countries levy a tax on banks’ balance sheets, to pay for future bailouts or the recent one. It sounds appealing. And since finance is global, global action would certainly be more effective than different countries going their separate ways. But the big danger is that the tax – like an insurance premium – entrenches the idea that banks should be bailed out when they run into trouble.

That would be a huge mistake. It would encourage banks to continue to run huge risks, safe in the knowledge that tails they win, heads taxpayers lose. As I argue in much greater detail in Aftershock: Reshaping the World Economy After the Crisis, there is a better way to break up this racket.

  • Tighten and improve regulation.
  • Restructure banks so that they can be wound up quickly and safely if need be.
  • And break them up, to curb their monopoly profits and political power and ensure they are allowed to fail.

To its credit, the IMF acknowledges the need for governments to create effective mechanisms to wind banks up. But I doubt whether such a commitment can be credible unless banks’ financial and political clout is broken.

East Asia’s dynamic economies could stabilise carbon emissions by 2025

China and the next five largest energy-consuming countries in East Asia could stabilise their greenhouse gas emissions by 2025 without compromising growth, according to a major new World Bank report.

The report, Winds of Change: East Asia’s Sustainable Energy Future, says that an extra investment of $80bn per year – or an average of 0.8% of regional GDP – in energy efficiency and renewables capacity could result in greenhouse-gas emissions in China, Indonesia, Malaysia, the Philippines, Thailand and Vietnam peaking within 15 years.

Hat tip: BusinessGreen (via ViewsFlow)