According to an op-ed by Paul Krugman in the NY Times today, China is not only a currency manipulator, but also a cause of the world financial crisis. I usually have some respect for Mr. Krugman, so I’ll try to take his op-ed seriously.
Senior monetary officials usually talk in code. So when Ben Bernanke, the Federal Reserve chairman, spoke recently about Asia, international imbalances and the financial crisis, he didn’t specifically criticize China’s outrageous currency policy.
But he didn’t have to: everyone got the subtext. China’s bad behavior is posing a growing threat to the rest of the world economy. The only question now is what the world — and, in particular, the United States — will do about it. Some background: The value of China’s currency, unlike, say, the value of the British pound, isn’t determined by supply and demand. Instead, Chinese authorities enforced that target by buying or selling their currency in the foreign exchange market — a policy made possible by restrictions on the ability of private investors to move their money either into or out of the country.
Wait a minute. Underlying this passage are a mouthful of myths and fictions that I can’t just let pass. China is a currency manipulator but countries like Great Britain is not?
It is true that China has more restrictions over the movement of money into and out of the country than most Western countries, but China is hardly the only country that manipulates the value of its currency. Every country – including the European Union – controls the value of its currency by manipulating the supply and demand of its currency. The U.S. currently sports a weak dollar policy and set the value of its currency by buying and selling bonds, setting the fed fund rate, changing the reserve requirements, even interfering in the foreign exchanges at times, etc.
One should remember that China is a developing nation and its restriction on the movement of money is something which even Mr. Kruagman concedes in the op-ed may be appropriate. Lest we forget, it was the unchecked global movement of money by currency speculators that devastated economies of so many countries in Asia during the 1997 Asian Financial crisis. At this critical moment, China has a duty to itself, as well as to the rest of the world, that something like the 1997 crisis does not happen.
Kraugman goes on:
Many economists, myself included, believe that China’s asset-buying spree helped inflate the housing bubble, setting the stage for the global financial crisis. But China’s insistence on keeping the yuan/dollar rate fixed, even when the dollar declines, may be doing even more harm now.
I think that is going a little too far. China is not responsible for the U.S. housing bubble.
The housing bubble was fueled by easy credit made possible by a deluge of exotic financial instruments such as mortgage-backed assets and credit default swaps. It was financial institutions from all corners of the world (investment banks, commercial banks, hedge funds, pension funds) – not the Chinese government – that flocked to purchase these instruments. Unfortunately, due partly to a lack of regulations, many institutions gobbled up these new exotic assets without truly understanding the risks.
For the few initiated who want to dig further for the cause of the financial crisis, the crisis had its roots in U.S. domestic policy. Throughout the 1990’s and 2000’s, the U.S. government aggressively pursued a policy to spread home ownership. The government encourage banks to hand out easy credit. Despite signs of a bubble, the government mandated Fannie Mae and Freddie Mac to buy up mortgages from banks so banks could lend out even more, causing a precipitous cycle. It was in this environment that Wall Street popularized the exotic financial instruments which greased the bubble machine.
Americans need to own up for what has turned out to be bad policies. Yes, these are complicated issues. But don’t blame China for these troubles. (If we want to accuse China of helping to inflate the housing bubble, we might as well also accuse China of helping to cause the Iraq War, since the war was also funded in part with money borrowed from China.)
Krugman wrote further:
By pursuing a weak-currency policy, China is siphoning some of that inadequate demand away from other nations, which is hurting growth almost everywhere. The biggest victims, by the way, are probably workers in other poor countries. In normal times, I’d be among the first to reject claims that China is stealing other peoples’ jobs, but right now it’s the simple truth.
Now Krugman has become truly delirious. Is it ok or not ok to pursue a weak currency? Just when has it become not ok to pursue a weak currency during bad economic times? If what Krugman says is true, then isn’t the U.S. pursuit of a weak currency during economic hardtimes – achieved by lowering interest rates and expanding the money supply – also fundamentally flawed … and immoral?
Moving beyond Krugman’s confusing op-ed, let’s take a more realistic look at what is going on.
Most of the world today is still mired in a deep recession. But as leaders of the major economies in the G20 has agreed, the best way forward is for the major economies to coordinate with each other in stimulating each country’s economy. During these difficult times, it is imperative that the major economies refrain from being protectionism and engaging trade wars with each other.
China has maintained a stable currency policy for the last decade or so. It looks like China may finally be leading the world in a fragile global recovery. This is hardly the time rock the boat by scapegoating China or demanding China change its currency policy.
Looking to the future, we can take a few notes. As the Chinese economy becomes bigger and more powerful, it can no longer continue to be an export-driven economy. The trade deficit between the U.S. and China is also not sustainable for the long term.
But what is the best way to proceed forward? Would increasing the value of the yuan fix everything?
Probably not. The trade imbalance between the U.S. and China is more complicated than that.
Even if China’s currency were not an issue, people will still blame China’s labor standards, healthcare system, savings rate, intellectual property regime, tax code, environmental regulations, etc. whenever trade frictions occur. As long as there is a difference between China and the U.S., protectionists will latch onto that as the cause for disengaging trade.
Personally I believe that trade can be sustainably conducted between developing and developed nations. There will always be complex issues, but these issues can be worked out.
On the flip side, the fact of the matter is that U.S. policy also has plenty to blame for causing the trade deficit.
The U.S. has the most advanced technologies and the most formidable companies in the world. Yet the U.S. limits technology exports to China and prevent Chinese companies from investing in U.S. companies.
The official explanation is that the U.S. fears that China’s military will modernize too quickly if China is allowed to purchase advanced U.S. technologies. But technology moves so fast these days, and information flows so readily, China will eventually get what it needs. The end effect of the embargo serves only to breed more political mistrust and distort trade.
A better way forward is for the U.S. to lift the technology embargo so U.S. companies can sell advanced technologies that China needs and make the money to develop the next generation of technologies. U.S. companies should be allowed to accept investments from Chinese companies to access the resources needed to more vigorously develop better products, services, and technologies. (National security concerns still count. But the current prejudice against Chinese investment reflect more paranoia than national security.)
Relation between the U.S. and China will shape the 21st century, Obama had said earlier this year.
The U.S. and China must not to get mired in suspicion, distrust, protectionism or get entrenched in bickering about each others’ differences. There will be many give and takes along the way. But the thrust of the way forward should be to strive onward, cooperate, and openly (and confidently) develop each side’s strength.