ONE of the few good things about the Great Recession of 2008-09 was a merciful absence of complaints from America’s Congress about China’s currency. The yuan’s gradual appreciation stopped in July 2008, and China has since kept its currency tightly pegged to the dollar. But even as America suffered its worst downturn in the post-war period, its legislators steered clear of ranting against China.
That restraint was driven partly by fear. At the depths of the crisis even the most myopic Congressmen worried about a descent into 1930s-style protectionism. And it was driven partly by the facts. As investors’ flight to safety strengthened the dollar in late 2008, the yuan rose along with it. With America’s imports slumping it was hard to blame Chinese workers for American joblessness. And thanks to its huge domestic stimulus China added to global demand last year, as its current-account surplus shrank sharply.
Now things have, unfortunately, gone into reverse. As policymakers in both countries shift from cushioning recession to managing recovery, the rigidity of the yuan is, once again, becoming a source of tension—one that a still-fragile global recovery can ill afford.
America sounds increasingly determined to push its exports, and its attitude to China has hardened. Mr Obama has set a goal of doubling exports in five years (see article) and has promised to “get much tougher” over what it regards as unfair competition from China. Speculation is rising in Washington, DC, that the Treasury will brand China a currency “manipulator” in its next exchange-rate report. With America’s unemployment at 9.7% and the mid-term elections approaching, the appeal of China-bashing is rising in Congress, too. Several senators recently revived a mothballed demand that the Commerce Department should investigate China’s currency regime as an unfair trade subsidy.
Beijing, in turn, shows little sign of budging on the yuan, even though the latest figures show surprisingly strong export growth and higher-than-expected inflation. Zhou Xiaochuan, the head of China’s central bank, caused a brief flurry in currency markets when he argued on March 6th that keeping the yuan stable against the dollar was “part of our package of policies for dealing with the global financial crisis” from which China would exit “sooner or later”. But he made it quite clear that China would be cautious and gave no hint that sudden exit was imminent. In recent days various other Chinese officials have put even more emphasis on the stability of the currency, bristled at outside pressure to hurry up and denounced American “politicisation” of the exchange-rate issue.
A speedy end to the dollar peg makes economic sense for China as well as for the world. A stronger, more flexible currency would make it easier for China to control inflation and asset bubbles. A dearer yuan would also help rebalance China’s economy towards domestic spending by boosting Chinese consumers’ purchasing power, discouraging excessive investment in manufacturing and squeezing corporate profits. That would put the global recovery on a steadier footing, especially if a stronger yuan were mirrored by appreciation of the currencies of other Asian emerging economies. And China would gain politically by helping to diffuse protectionist pressure from abroad.
But it would not be a magic bullet, either within China or outside. Rebalancing China’s economy will require big structural reforms, from tax to corporate governance, as well as a stronger currency. A stronger yuan would not suddenly bring back millions of jobs to America. Since America no longer makes most of the products it imports from China, a stronger yuan would initially act more like a tax on consumers.
Soft-soaping, not sabre-rattling
Will the administration’s new tough talk move things in the right direction? Those who argue in favour of sabre-rattling do so on two grounds: first, that it is likely to shift China’s position, and second, that a stronger stance against China’s currency from the White House will diffuse protectionist sentiment in Congress. Both are dubious. China’s reactions so far suggest that American complaints make an imminent currency shift less, not more, likely. And a row could spur rather than diffuse anti-China action in Congress.
Rather than raising a bilateral ruckus, America would be far better off convincing other big economies in the G20 to press together for a yuan appreciation as part of the world’s exit strategy from the crisis. Cool and calm multilateral leadership will achieve more, with fewer risks, than a Sino-American currency spat.
The west is wrong to obsess about the renminbi
By Michael Spence
Published: January 21 2010 22:03 | Last updated: January 21 2010 22:03
China is being pressed to revalue its currency. It is a mistake to become obsessed by this. What the global economy needs is for China to grow and for its current account surplus to fall.
Some (inside and outside China) see this as a static zero-sum game for global market share. This is unhelpful. The main issues are growth and the restoration of global demand. The latter is in short supply because of the rise in US savings, caused by the crisis but likely to persist. China has a big contribution to make – in the order of a third of the deficit in global demand. Its high growth figures and rebounding trade, with imports outgrowing exports, suggest the crisis policies are working. But they may have to be reined in to avoid overheating, inflation and asset bubbles. Further, surpluses serve no strategic purpose in a developing country that is fully financing its investment.
The singular focus on the exchange rate appears based on the assumption that it is the key cause of the surplus and the main policy instrument for removing it. The reality is more complex. Reducing the surplus in China involves deep structural change, much as reducing the US deficit does. The high savings in China are embedded in the structure of the economy. The government controls too much income directly and through ownership of the state-owned enterprises. Household income at 60 per cent of gross domestic product is way below international norms and household saving at 30 per cent of disposable income is high. This puts household consumption in the range of 40-45 per cent of GDP. A significant change in both these ratios is needed to sustain growth, make better use of the now large domestic market and guide the structural change in the economy associated with the middle-income transition, and to reduce the surplus without damaging growth.
Without these structural changes, if the currency were floating and convertible (no capital controls), the outcome is most likely to be continued high savings, a trade surplus matched by an outflow of private savings to foreign investments and slow growth. Exchange rate appreciation by itself will not get rid of the surplus.
Rapidly rising domestic demand is essential to sustaining high growth in China. The traditional export sectors are in decline anyway. Incomes are rising. Comparative advantage is shifting to high value-added sectors. Domestic demand and new export sectors are needed to drive growth and guide the structural transformation of the economy, much of which is in the complex middle-income transition. In this dimension, China’s economic interests and global ones are aligned. The excess savings are in the order of 10 per cent of GDP. That needs to turn into household consumption.
It is understood within China that an appreciating currency is needed to sustain pressure for structural change on the supply side . Insufficient appreciation will cause the structural shifts to stall. That will impact productivity growth and incomes.
There are vested interests in China in the status quo. The crisis may have temporarily strengthened their hand. They too tend to hold a static zero-sum version of the issue. Pressing for exchange rate appreciation strengthens their hand. But this resistance is temporary. No one thinks that the transition to advanced country incomes in the next two decades will be built on export-oriented, relatively low value-added, labour-intensive, manufacturing-processing industries.
Will an appreciating currency leave the large rural population few options to advance as labour-intensive exports decline? It is a concern inside China. At this stage of growth, neither a pegged exchange rate nor subsidies are desirable. The export-led manufacturing sector – a big employer in earlier stages of growth – will not be the main source of jobs in the future. That will come instead from the domestic economy, the growing middle class and services they consume.
So China’s growth will require structural change, a shift to the domestic market, the elimination of the current account surplus and an appreciating currency. To be fair, one can view the exchange rate as a trigger for deeper structural reform. The problem is the signal being sent. A narrow focus on the exchange rate signals an incomplete understanding of the complexity of the transition. It plays into the hands of the zero-sum proponents inside and outside China.
The writer received the 2001 Nobel memorial prize in economics and chairs the Commission on Growth and Development
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