On November 16, the eve of President Obama’s recent trip to China, two very interesting op-ed pieces appeared in the New York Times. One, The Great Wallop, was by Niall Ferguson, an economic and financial historian and Professor at Harvard. The other, World Out of Balance, was by Paul Krugman, a Nobel Prize-winning economist specializing in international economics and finance.
The subject of the two pieces was the same and one this blog has addressed several times: China’s economic relationship to the United States, and the unsustainability of the decade old disequilibrium caused by the pegging of the grossly undervalued Chinese renminbi to the dollar.
As Ferguson points out, this currency peg has enabled the immensely rapid, export-financed development of China, while also financing overconsumption by the U.S. In each year from 2000 to 2008 the U.S. outspent its income, running up large trade deficits, in particular with China, and facilitating a quadrupling of China’s GDP over the same period. A truly extraordinary economic symbiosis resulting in a major economic and financial imbalance.
Ferguson dubs this symbiosis “Chimerica” and says, “In essence Chimerica constituted a credit line from the People’s Republic to the U.S. that allowed Americans to save nothing and bet the house on…well, the house.”
True, China did let their currency rise relative to the dollar in small increments from 2005 to 2008, but has maintained the peg at 6.83 renminbi to the dollar since the financial crisis worsened in 2008. In recent months, as the dollar has declined, this peg has caused the renminbi to become more undervalued relative to other major currencies such as the euro and the yen, thus aggravating the trade positions of many other nations relative to China.
With the onset of the Great Recession, world trade collapsed and China’s exports declined coincident with the decline in the U.S. demand for manufactured goods. For a while, then, the disequilibrium lessened in intensity. Now, however, with some recovery in demand, we could find ourselves right back where we were.
To quote Paul Krugman: “So picture this: month after month of headlines juxtapositioning soaring U.S trade deficits and Chinese trade surpluses with the suffering of unemployed American workers. If I were the Chinese government, I’d be really worried about that prospect”.
Krugman goes on to say that the Chinese evidently don’t get it. Instead of considering a change in their currency policy, they tell the U.S. to raise interest rates a curb fiscal deficits, in other words, make our unemployment problem worse. He worries that the Obama administration may not get it either, judging from the absence of any urgency in statements about currency policy.
Why is this so important right now? As Ferguson points out, there are three reasons why it is in our best interest that Chimerica comes to an end:
First, and most obvious is that adjusting the exchange rate between the two currencies would help reorient the U.S. economy by making American exports more competitive in China, the world’s fastest growing big market.
Second, by increasing Chinese demand for U.S. goods it would lessen “the potentially dangerous reliance of American economic policy on measures to stimulate domestic purchasing. American fiscal policy is clearly on an unsustainable path, and the Federal Reserve’s negligible interest rates and the printing of dollars are artificially inflating equity prices.”
Third, revaluation of the remninbi would reduce the risk of growing international friction over trade. As pointed out above, as the dollar declines relative to other currencies, so does the renminbi which is pegged to the dollar. Already there are stirrings about defensive counter measures on the part of other trading nations.
While it may appear difficult at first to see what China would gain from a revaluation, history has consistently shown that exporting nations can live and prosper with rising currency values as long as their productivity gains are strong. China fits that mold.
Unhampered global free trade as been, as Ferguson points out, the very foundation of China’s economic success. A perpetuation of the currency distortion puts that foundation at risk.
Until now, all we’ve heard from China are some mutterings about switching from the dollar peg to some form of exchange-rate management and replacing the dollar as the primary reserve currency.
As far as we can tell, unless there were unreported closed-door meetings, Obama’s visit made no progress on this important subject.
In the meantime, the administration and the congress, in a fret about unemployment, are agitating about a new supplemental stimulus package. A Chinese revaluation would be a genuine, costless stimulation package.
I hope they all understand that!