What should the U.S. do about the Chinese currency?
C. Fred Bergsten, the Director of the Peterson Institute for International Economics, has some suggestions. (The Chinese Exchange Rate and the US Economy, January 31, 2007).
First, both the U.S. and China need to deal with fundamentals - the U.S. needs to increase its savings rate - cutting the size of the government's deficit would be a good place to start - and the Chinese need to increase the role of domestic consumption (relative to exports) in driving growth:
China can do so most easily through higher government spending on health care, pensions, and education. Such new government programs are needed for purely internal reasons anyway because of the unrest in China that has resulted from the demise of state-owned enterprises that provided these benefits in previous times. They would reduce the precautionary motive for household saving in China and boost private as well as government demand, contributing importantly to the needed international adjustment.
While these measures should help reduce the U.S. trade deficit, and the Chinese surplus, measures to stop Chinese currency manipulation are also important:
First, it is clear that China has aggressively blocked appreciation of the RMB through its massive intervention in the currency markets and that the Treasury Department has severely jeopardized its credibility on the issue by failing to carry out the requirements of current law to label China a “currency manipulator.”... Treasury has thus been reducing its criticism of China's currency practices even as the RMB has become increasingly undervalued and China's external surpluses have soared.
The Treasury policy needs to be changed sharply and quickly. The administration should notify the Chinese immediately that, if China fails to make a significant “down payment” appreciation of at least 10 percent by the time of the next meeting of the Strategic Economic Dialogue in May 2007 and prior to the release of Treasury's next semi-annual report, it will be labeled a “manipulator.” This would trigger an explicit US negotiation with China on the currency issue.
...the administration should notify its G-7 partners and the IMF that it plans to make such a designation, in the absence of major preventive action by China, with the goal of galvanizing a multilateral effort on the issue and reducing its confrontational bilateral character. The objective of that international effort, hopefully spearheaded by the IMF through its new “multilateral surveillance” initiative, should be a “Plaza II” or “Asian Plaza” agreement [in contrast to the Plaza Accord of 1985 - Ben] that would work out the needed appreciation of the major Asian currencies through which the impact on the individual countries involved (including China) would be tempered because they would not be moving very much vis-a-vis each other....
...the administration (with as many other countries as it can mobilize) should also take a new multilateral initiative on the trade side by filing a WTO case against China's currency intervention as an export subsidy. As chairman Ben Bernanke indicated in his highly publicized speech in Beijing last month [The Chinese Economy: Progress and Challenges - Ben], in connection with the first Strategic Economic Dialogue, China's exchange rate intervention clearly represents an effective subsidy (to exports, as well as an import barrier) in economic terms. It should be addressed as such.
...if the multilateral efforts fail, the United States will have to address the China currency issue unilaterally. Treasury can pursue the most effective unilateral approach by entering the currency markets itself. It is impossible to buy RMB directly, because of its continued inconvertibility, so Treasury would have to select the best available proxies in the financial markets. The intent of a US policy message would be crystal clear, however, and at a minimum there would be a further sharp increase in speculative inflows into the RMB that would make it even more difficult for the Chinese authorities to resist their inflationary consequences and thus the resultant pressures to let the exchange rate appreciate. (Other undervalued Asian currencies, notably the Japanese yen, could be purchased directly with immediate impact on their exchange rates against the dollar.)
The United States has of course conducted such currency intervention on many occasions in the past, most dramatically via the Plaza Agreement in 1985 and most recently when it bought yen to counter the excessive weakness of that currency in 1998 (when it approached 150:1). All those actions have been taken with the agreement of the counterpart currency country, however, and usually in cooperation with that country. This would be the essence of the proposed “Plaza II” or “Asian Plaza” agreement, as suggested above, and the multilateral approach would be preferable now as always and should be pursued vigorously by the administration. Failing such agreement, however, the unilateral option is available and might have to be adopted.
...the administration should quietly notify the Chinese that it will be unable to continue opposing responsible Congressional initiatives to address the issue. Congress should then proceed, hopefully in cooperation with the administration, to craft legislation that would effectively sanction the Chinese (and perhaps some other Asians) for their failure to observe their international currency obligations.
Such unilateral steps by the United States, although decidedly inferior to the multilateral alternatives proposed above, could hardly be labeled as “protectionist,” since they are designed to counter a massive distortion in the market (China's intervention) and indeed promote a market-oriented outcome. Nor could they be viewed as excessively intrusive in China's internal affairs, since they would be no more aggressive than current US efforts on intellectual property rights and other trade policy issues (including the filing of subsidy and other cases on such issues with the WTO). Such steps should therefore be considered seriously if China continues to refuse to contribute constructively to the needed global adjustments and if the Treasury Department continues to whitewash the Chinese policies by failing to carry out the clear intent of the law fashioned by this committee almost two decades ago.
To a considerable extent, this is a reprise, development, and update, of Bergsten's testimony to the Senate Finance Committee last year: The US Trade Deficit and China (March 29, 2006).
Parenthetically, Lawrence Summers ("History holds lessons for China and its partners," Financial Times, Feb 25) recently warned about putting too much faith in the efficacy of friendly advice:
An additional lesson [from the experience with Japan in the late-eighties and early-nineties - Ben] is the need for modesty regarding economic policy dialogues that seek to create pressure for change. Events and national and political decisions, not international communiqués, shape economic outcomes. The impact of events beyond the control of governments – the collapse of Japan’s asset markets, information technology’s spur to US productivity growth, the Asian financial crisis – dwarfed the issues debated in economic dialogues.
Even where government policies might have significant impact, there is no evidence that Japan in the 1980s and 1990s made any changes in domestically sensitive structural policy areas such as housing finance, social security or retail regulation in response to the US Structural Impediments Initiative or its successors. Policy in areas of this kind is shaped by domestic politics; if heavy-handed pressure makes it easier for special interests to invoke nationalism as they resist change, high-profile dialogues can be counter-productive. In a world where goodwill is scarce, heavy-handed dialogues engender resentments that spill over into other spheres.
James Galbraith (What Kind of Economy?, The Nation, March 5) doesn't think we need to do anything:
On China the Hamilton Project--otherwise resolutely against interventions--has harnessed widespread anxieties to its own objectives. The Hamiltonians endorse the idea that China is a challenge. It is a challenge, they say, to be dealt with not via tariffs or quotas but by a massive revaluation of the Chinese currency, the renminbi (RMB), for which liberal senators like Charles Schumer and economists like Tom Palley also forcefully call.
Would a big RMB revaluation solve America's China-trade "problem"? Well, it might hit China's exporters (and also, inevitably, its workers) hard. Multinationals might migrate to other low-wage countries; American importers might seek other sources of supply, in other corners of the Third World. But this much is sure: Not a single low-wage job would return to the United States. So, American consumers could be harmed, while American workers wouldn't be helped. One has to ask: What gives? Why is this an issue for the progressive agenda?
Who really benefits from the pressure that our Treasury Secretary from Goldman Sachs, Henry Paulson, has been putting on Beijing? Well, speculators have flooded Chinese property markets in the past few years, contributing to a massive bubble in Shanghai and elsewhere. (China's trillion-dollar asset reserves come largely from sterilization of those investments--a central bank maneuver to insure that dollars do not circulate in China--and not just from its trade surplus.) If Paulson succeeds, they clearly would make out nicely. It may be that some of those speculators live in New York. That may explain Paulson's call--and Schumer's support--for an RMB revaluation. But it's not a reason for the rest of us to jump on board.
Bergsten points to reasons beyond speculative interests. He points to popular concern with the trade deficit with China that may lead to misconceived protectionist measures, and to trade imbalances might lead to a "hard landing" and U.S. recession, as reasons for concern with the renminbi:
These global imbalances are unsustainable for both international financial and US domestic political reasons. On the international side, the United States must now attract about $8 billion of capital from the rest of the world every working day to finance the US current account deficit and its foreign investment outflows. Even a modest reduction of this inflow, let alone its cessation or a selloff from the $14 trillion of dollar claims on the United States now held around the world, could initiate a precipitous decline in the dollar. Especially under the present circumstances of nearly full employment and full capacity utilization in the United States, this could in turn sharply increase US inflation and interest rates, severely affecting the equity and housing markets and potentially triggering a recession. The global imbalances probably represent the single largest current threat to the continued growth and stability of the US and world economies.
The domestic political unsustainability derives from the historical reality that dollar overvaluation, and the huge and rising trade deficits that it produces, are the most accurate leading indicators of resistance to open trade policies in the United States. Such overvaluation and deficits alter the domestic politics of US trade policy, adding to the number of industries seeking relief from imports and dampening the ability of exporters to mount effective countervailing pressures. Acute trade policy pressures of this type, threatening the basic thrust of US trade policy and thus the openness of the global trading system, prompted drastic policy reversals by the Reagan Administration, to drive the dollar down by more than 30 percent via the Plaza Agreement in the middle 1980s, and by the Nixon Administration, to impose an import surcharge and take the dollar off gold to achieve a cumulative devaluation of more than 20 percent in the early 1970s.
The escalation of trade pressures against China at present, despite the strength of the US economy and the low level of unemployment, is the latest evidence of this relationship between currency values and trade policies. With deep-seated anxieties over globalization already prevalent in our body politic, and the failure of the Doha Round to maintain the momentum of trade liberalization around the world, continued failure to correct the currency misalignments could have a devastating impact on the global trading system.
Revised Feb 28: On this topic see What's Behind the China Currency Valuation Issue? (International Economic Law and Policy Blog, Feb 27), including the comments, where Galbraith discusses the issue in more depth with Simon Lester and others.