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The U.S. China Dispute over Renminbi: Who is Right?

Recently, a rising chorus can be heard in the U.S. accusing China of “manipulating” the value of the RMB. In a recent op-ed, Krugman characterized Chinese policy as an “anti-stimulus” to the rest of the world. In an editorial op-ed, the NY Times staff accused China of playing a “beggar-thy-neighbor competitive devaluation” that is “threatening economies around the world … fueling huge trade deficits in the United States and Europe … [and] crowding out exports from other developing countries, threatening their hopes of recovery.” 130 Congressman sent letter to the Obama administration urging Obama to take action against the yuan.

In response, China has denied that its policy has caused harm to the world. In contrast, China has argued that a stable Yuan is a major factor that has kept the world from economic free fall today. The trade imbalance between the U.S. and China is caused more by stringent U.S. export restrictions than the value of the yuan.

I am not going to go over every economic theory there is about international trade (there are so many), but will make a few observations.

Has China been pursuing an unfair currency policy?

I do not think so. The value of the Yuan is currently fixed to the Dollar by the Chinese government. This is not intrinsically unfair. As a recent Wall Street Journal explained, there is no “free market” “fair” evaluation of currency as there is for consumer or commodity goods. The value of currencies are controlled by various central banks that in turn control the supply of currencies from around the world. According  to the Wall Street Journal:

President Obama has picked up this theme, calling last week for Beijing to adopt “a more market-oriented exchange rate” that “would make an essential contribution to that global rebalancing effort.” Less diplomatically, 130 Members of Congress sent a letter to Treasury this week demanding that unless China lets the yuan rise in value, the U.S. should impose tariffs on Chinese goods. Just what the world needs: a trade war.

At the core of this argument is a basic misunderstanding of monetary policy. There is no free market in currencies, as there is in wheat or bananas. Currencies trade in global markets, but their supply is controlled by a cartel of central banks, which have a monopoly on money creation. The Federal Reserve controls the global supply of dollars and thus has far more influence over the greenback’s value than any other single actor.

A fixed exchange rate is also not some nefarious economic practice rare in human affairs. From the end of World War II through the early 1970s, most global currency rates were fixed under the Bretton-Woods monetary system created by Lord Keynes and Harry Dexter White. That system fell apart with the U.S.-inspired inflation of the 1970s, and much of the world moved to “floating rates.”

But numerous countries continue to peg their currencies to the dollar, and with the establishment of the euro most of Europe decided to move to a fixed-rate system. The reason isn’t to get some trade advantage against their neighbors but to gain the economic benefits of stable exchange rates—and in some cases a more stable monetary policy. A stable exchange rate eliminates a major source of uncertainty for investment decisions and trade and capital flows.

While the value of currencies is in large part controlled by central banks from around the world, private speculative trading can also greatly influence the value of currencies – at least in the short-term, as occurred in the Asian Financial Crisis of the late 1990’s. Currencies become akin to stocks – or commodities like gold or silver. Their values can be speculated up or down, with devastating effects on people, trade and the global economy. When the Asian Financial Crisis hit, there were no calls for “market valuation” of the yuan, only gratefulness that China kept its yuan stable.

There is no one answer regarding whether a fixed or a floating exchange rate system is better. At times, fixed currencies work better to foster international trade. At other times, a limited floating system (which is what the U.S. has) work better. But whatever the system, the end goal has always been to stabilize currency to foster international trade.

I don’t mind arguing about what the exchange rate between the RMB and Dollar should be, but reflexively arguing the merits of fixed vs. floating in terms of fair vs. unfair, good vs. evil, or right vs. wrong makes little sense to me.

What about purchase power – isn’t the Yuan undervalued in terms of purchasing power?

More recently, China has been accused of pursuing a “beggar-thy-neighbor” policy. Many in the U.S. have accused China’s currency to be severely undervalued. According to the Economist Big Mac Index, the yuan is alledgedly undervalued by as much as 49%.

This is absurd!  According to Prof. McKinnon of Stanford, using the same index, the RMB was supposed to be “properly valued” in terms of purchasing power as of 2009, and now in 2010, the RMB is undervalued by as much as 49%???

[Aside: The Economist’s Big Mac index evaluates the value of currencies by comparing the price of MacDonald Big Macs sold in various currencies in markets around the world. The reality is however that so many other things go into the pricing of a Big Mac – including local taste, market segmentation, etc. I don’t think you should calculate the exchange rate of a currency – value of entire economies – based on price of a Big Mac!]

The truth is that in general there is no easy way to calculate the fair value of currency based purchasing power – even amongst developed economies. As Prof. McKinnon explained:

In a world of fluctuating exchange rates, nobody can have any accurate idea of what is a fair or “equilibrium” level for the exchange rate. … In economies open to foreign trade, Cassel suggested that, on average, exchange rates should line up so that country A’s currency has the same purchasing power over a representative basket of goods and services as that of country B.

In poor countries with low wages, the prices of nontradable goods and services (such as haircuts) are much lower than the prices of nontradables in wealthy (high wage) countries— even though the prices of highly tradable goods such as textiles and automobiles are similar. So one dollar will have greater purchasing power in a poor country. But how much lower is “normal”?

Using data from more than one hundred countries, researchers at the University of Pennsylvania have made such a calculation by pricing out a common “international” basket of goods in each currency. They found that, at prevailing exchange rates, poor countries do have much lower price levels. But the data collecting is so onerous and expensive they can only construct “The Penn World Tables” once every ten years!

Forces having little to do with purchasing power can also influence the value of a currency – even “free-floating” ones like the Yen – as described in this economist article (requires subscription).

In the case of China, not only is comparing purchasing power against developed economies hard, it may actually not be conceptually possible for now. As this McKinsey report explains, China is still undergoing many basic reforms in its economy (land reform, reform of the energy sector, state-owned-enterprise reform, social welfare, among others). Until those reforms are complete, the price of many goods and services in China is not easily convertible. Any index derived from prices in China taken blindly on face value is sure to be meaningless.

Is the U.S. trade deficit with China a symptom of an undervalued yuan?

Most economists (as do leaders in China) understand that overall balance of account between nations is important for a sustainable global trade environment. But as I explained in an earlier post, deficit in balance of account between nations is caused by differences in investment and savings rates between economies, not the exchange rate.

Consider this basic thought exercise:

Suppose the Chinese yuan were to become cheaper by 50%, what would happen to the trade deficit?

1. Would the deficit decrease by half, with Americans buying exactly what they bought before and pocketing the savings from China’s currency devaluation?

2. Would the trade deficit remain the same as before, with lavish consumers consuming twice as much as before, consuming all the savings arising from China’s currency devaluation?

3. Would the deficit increase, with Americans buying more than twice as much goods as before?

I do not know the answer (the answer probably lies somewhere between the first and second scenario), but the point is not to answer which scenario would occur, but to contemplate the point that unless Americans are able to change investment / savings rate on an aggregate level, trade deficit is not going to change. As Prof. McKinnon emphasized, “[e]conomists—and the politicians they indoctrinate—must discard the false theory that one can use changes in the exchange rate to control the net trade balance in a predictable way.”

The situation regarding trade deficit is made more complex when we discuss deficits amongst groups of nations. China has trade deficits with South Korea, Japan, Latin America and 58 less-developed countries. When we have multilateral trade, bilateral trade deficit is not per se bad. Depending on the trade relationships amongst countries, it is possible for certain bilateral economies to register persistent trade deficits even though for each country the balance of accounts against the world is more balanced.

Has China been trading unfair?

Protectionist sentiments have been on the rise in the U.S. recently, with acrimonious accusations levied against China for not trading fair. The spat over China’s currency exchange rate is but the latest manifestation.

But the fact of the matter is that China and U.S. are at very different stages of economic developments. Even if the whole of the Chinese economy operates using the dollar only, many things will still appear inherently unfair.

People in China (and across the developing world for that matter) work more for less pay. Average wage in China is some 1/10 of that in the U.S. The labor standards, environmental standards, and social safety networks in China are all weaker than that in the U.S. Even between developed nations, differences in labor standards and fiscal policies (involving subsidies, currencies, etc.) between European nations, Japan and the U.S. still lead to regular trade disputes.

Does this mean the U.S. should disengage from international world – or at least reduce trade with developing nations like China until they come to the same standard as the U.S.?

I don’t think U.S. should disengage from globalization in the name of unfair wages or devalued currencies. There are costs and benefits to being a low wage country with an inexpensive currency. It is China’s prerogative to decide what role it wants to play in the global economy. I’d be flabbergasted if China is really pursuing a policy of purposely devaluing its currency.  Why would any nation voluntarily want to devalue itself over an extended amount of time to be a slave to others?  The path to riches is to move up the wage ladder, not down. I’ve never heard of a story of a pauper bootstrapping its way to riches by depressing its wages.

Whatever role China chooses to occupy in the international trade system, China will have certain advantages and disadvantages, and so will the U.S.  People should not forget that the U.S. is still sole super power in the world and has advantages in people, technology, and infrastructure that no other country can match. The U.S. needs to start acting like itself again, instead of bickering about how unfair the world is.

We learn most about ourselves in harsh times. Differences will always exist in the world. Will we rise to see the inevitable differences amongst us to be a source of collective strength or will we find excuses to disengage from each other?

  1. r v
    March 29th, 2010 at 17:17 | #1

    If China does “adjust” the RMB exchange rate, it would do nothing at all.

    The theory is that if the Yuan is worth more, then there would be more export of US goods with the cheap dollar.

    But that’s a ridiculously illogical theory, based upon the assumption that if the Yuan changes value relative to US dollar, then the cost to Chinese manufacturing, labor, and raw material would be higher.

    In reality, if the Chinese Yuan is “revalued” instantly, then instantly, prices and labor cost in China would also instantly change.

    Result: 1 Yuan may be worth more than before, but in China, every thing will cost fewer Yuan.

    Secondary result: Things made in China are still going to be cheap. US will still have a trade deficit.

  2. March 30th, 2010 at 11:32 | #2

    @ r v

    Secondary result: Things made in China are still going to be cheap. US will still have a trade deficit.

    Right. Japan was forced by the U.S. government to re-valuate the Yen by 200% in a short period of 2 years in the 80’s. U.S.’s spending habits never changed and the trade deficit continued just the same.

    Professor Jiang Ruiping: Revaluation of Japanese Yen, a historical lesson to draw: analysis

  3. r v
    March 30th, 2010 at 12:09 | #3

    YinYang,

    Furthermore, all these fluctuations will just create more chaos and currency speculation in the Chinese economy, and cause more inflation in China.

    If one read modern Chinese history very carefully, out of control inflation was one of the key factors that led to KMT’s downfall during the Chinese Civil War.

    And the CCP made sure in 1949 during the liberation that they would keep inflation under control, primarily by setting currency and commodity trading rates in the market, and use the government to peg the key commodity prices.

    Pegging the RMB to the dollar is a more recent policy, but it has the same exact intended purpose, eg. to stabilize the economy and control inflation.

  4. March 30th, 2010 at 13:23 | #4

    @r v, Allen,

    Also, Zhang Monan has an article out at the China Daily where she argued, “US is the true money meddler.” Zhang is an economics researcher for the State Information Center.

    US is the true money meddler
    By Zhang Monan (China Daily)
    Updated: 2010-03-23 07:51

    Editor’s note: By tracking a series of financial policies of White House since last year, the article exposes the manipulation of dollar by U.S. who pursues its own recovery only.

    Washington has chosen to depreciate the dollar as a tool to cut down on its foreign debts since World War II.

    A group of 130 lawmakers from the United States sent a letter last Monday to the US Treasury calling on the Obama administration to pressure China on its exchange rate.

    Accusing the Chinese government of subsidizing exports, they claimed that the “artificially undervalued” yuan is unfair to foreign competitors and puts China’s exporters at an advantage.

    This laughable accusation exposes Washington’s conspiracy to mislead people from the real currency manipulator that has caused turbulences in the global financial market: the US. To transfer the impacts of the global financial crisis to foreign countries, the Obama administration has adopted a monetary policy that only aids its own economic recovery.

    When the global financial crisis began to careen at the start of last year, nearly every country turned to a “de-leveraging” financial policy to reduce financial risk. But the US, by taking advantage of the dollar’s position as the world’s leading currency, attracted a large amount of capital back into the US to balance its financial debt.

    As the crisis began to subside in early last March in China, the US opened its fluidity valve and embraced a monetary policy of quantitative easing. Consequently, the US capital market experienced a robust rebound, which, along with a large range of depreciation of the dollar, has prodded the US economy, especially its foreign trade, to recovery.

    However, as the world’s largest economy began to climb out of its recession during last year’s third quarter – during which a 2.2 percent economic growth was achieved – decision-makers in the White House believed it was time to halt the dollar’s weak position.

    To make up for its steep fall in the previous months, the dollar has bounced back by 10 percent since last November. But the economic outlook in the US’ European allies is dire. Following the rebound of the dollar and mitigation of the US’ financial difficulties, Portugal, Italy, Greece, Spain and Iceland have suffered a worsening fiscal deficit and spreading debt crisis. The deteriorating financial scenarios in these European nations has undoubtedly caused a domino effect to other members and triggered a serious crisis of trust across the European Union.

    Since the outbreak of the debt crisis in Greece last December, the value of the euro has continued to fall against the dollar. Since its historical 1 to 1.51 exchange rate against the US dollar, the euro has dropped by more than 10 percent over the past three months, added by speculations of international investment companies such as Goldman Sachs. Due to the fierce currency war with the dollar, partly for the leading role in the international currency system, the euro has plunged into a more difficult predicament since its establishment in 1999.

    The US has always adopted an egotistical and unilateralist dollar policy. The currency has been considered an effective instrument to balance the US’ national interests and manage crises.

    A depreciated dollar has helped boost US exports and reduce its trade deficits against other countries. In October, a month in which the dollar devalued by a large margin, the US trade deficit declined by 7.6 percent from the previous month to $32.9 billion. This massive large trade deficit reduction has effectively helped imbalances in US current accounts and spurred its economic revival. However, the huge fiscal deficit and government debt still remain a bigger concern to Washington. As the largest US government debt holder, China’s reduction in its holding of US Treasury bonds in the past three consecutive months has caused great concerns within the White House.

    Under these circumstances, Washington chose to appreciate the dollar in an attempt to reverse declining US debts, increase its attractiveness and mitigate growing concerns among its creditor about the safety of dollar-denominated assets. According to the US Treasury Department, the country is due to issue to foreign countries $478 billion of national debt in this year’s first quarter and $745 billion in the first half of this year. Washington certainly needs a strong dollar to support its debt issuance plan.

    According to a recent budgetary program unveiled by the Obama administration, the rate of the US national debt to its gross domestic product in the 2009 fiscal year was 83 percent and is due to rise to 94 percent in the 2010 fiscal year.

    Given that the US national debt is calculated according to the dollar, a depreciating dollar would help reduce the volume of its real debt and sustain Washington’s deficit-reliant financial policy. The US has actually chosen to depreciate the dollar as a main way to cut down its foreign debts since the end of World War II.

    Pressuring China to appreciate its currency and forcing the country into concessions on opening its financial market have served as part of the US’ monetary and financial campaign. The dollar, which has long been used by Washington as a forcible weapon to maximize its national interests and manage economic crises, still remains the Sword of Damocles hanging over the global financial market. But Washington’s foolish dollar manipulations also serve as the best evidence of figuring out who is the world’s largest currency manipulator and who should be levied by an anti-subsidy tariff.

    The author is an economics researcher with the State Information Center.

    (China Daily 03/23/2010 page8)

  5. George Monser
    March 31st, 2010 at 23:45 | #5

    @Allen

    Good article. But I think you omitted the main reason the US is griping to China about the exchange rate. It’s not trade deficits. The US has had staggering trade deficits for many years, but they haven’t cause much worry. What matters is the huge number of workers in the US who recently lost their jobs and can’t find even a lower paying job. This is a real tragedy. The same is true of the millions of Chinese workers who lost their jobs when the Great Recession began. Exchange rates have a real influence on the number of jobs in countries that trade with each other. What we need is quiet negotiation among all countries in the WTO, instead of political posturing and threats of a trade war.

  6. April 1st, 2010 at 07:47 | #6

    @George Monser #5,

    I agree with you that exchange rates do have a real influence on the number of jobs in each country. This is why both China and U.S. treat the issue seriously.

    I personally do not agree that exchange rate allows one country to take jobs away from another though. If we force the exchange rate of RMB to increase, there is no clear effect what that’s going to do. We could have less trade with no change in jobs or trade deficit – with everyone worse off. We could shift trade between U.S. and China to between U.S. and other nations. I suppose we could move some of the jobs off-shored from U.S. to China back to the U.S. But note that the reason those jobs went to China in the first place was because it was economically advantageous to do so. Shifting them back to the U.S. would provide benefits but as well as incur real costs to the U.S. economy.

    I agree with you though that trade does have an effect on economy which does have an effect on the state of a nation – and as such, trading partners need to cognizant of that and work with each other (quietly and constructively) to make sure trade makes sense for everyone involved.

  7. George Monser
    April 1st, 2010 at 13:31 | #7

    @Allen,

    America and China have both prospered from their mutual trade, and I believe this will continue. I don’t know how much an x% change in exchange rates would effect the number of jobs, but there are experts who know how analyse this. They should be the source of wisdom to resolve the current dispute.

  8. George Monser
    April 1st, 2010 at 13:59 | #8

    @Allen

    P.S. Experts not withstanding, every country has the right to set it’s own exchange rate, regardless of outside advice.

  9. April 1st, 2010 at 15:13 | #9

    @George Monse #7,

    I agree – the experts should analyze this. My problem is with the politicization of what should be “science.” It happens in many places – in health care reform, global warming debate. Tell us what we know and what we don’t know – then let us play politics with what we know or don’t know. Don’t weave politics into the facts – that makes things so much more complicated.

    To the extent economics is “science” and not “policy,” we really should ought to stop politicizing economics.

    @#8,

    Thanks. As a matter of principle, I do believe it. If I make a conscious choice – without force (as in slave labor) – to work for $1 per hour, I should be allowed to do so, I think.

  10. April 2nd, 2010 at 12:50 | #10

    Somehow I missed this article from NY Times last year.

    It’s No Time for Protectionism .

    By N. GREGORY MANKIW
    Published: February 7, 2009

    WHAT approach will the Obama administration and the Democratic majority in Congress take on international economic policy? It is too early to say for sure, but the signs so far are worrying.

    Just before his confirmation as Treasury secretary, Timothy F. Geithner turned up the heat on the Chinese regarding the dollar-yuan exchange rate. President Obama, he said, “believes that China is manipulating its currency. Countries like China cannot continue to get a free pass for undermining fair-trade principles.”

    Like many economists, I cringe whenever I hear the term “fair trade.” It is not that I am against fairness — who is? — but the word “fair” is so amorphous in this context as to defy definition. Most often, the slogan “fair trade” is little more than a rallying cry for protectionism.

    Just days after Mr. Geithner pointed his finger at China, Wen Jiabao, the Chinese prime minister, pointed his own finger right back. Speaking at the World Economic Forum in Davos, Mr. Wen blamed the United States for the economic crisis the world is now experiencing. He talked in particular of “the failure of financial supervision.”

    Most likely, Mr. Wen was aware that one of the important players in the United States supervisory system has been Mr. Geithner, who until recently was president of the Federal Reserve Bank of New York. In that role, Mr. Geithner was, for example, the primary federal regulator for Citigroup. Mr. Wen may have been suggesting — quite rightly — that the new Treasury secretary should focus his energy on fixing problems a bit closer to home.

    But timing aside, is Mr. Geithner right about the currency question? Are Americans hurt by China’s exchange-rate policy?

    Critics of China say it is keeping the yuan undervalued to gain an advantage in the international marketplace. A cheaper yuan makes Chinese goods less expensive in the United States and American goods more expensive in China. As a result, American producers find it harder to compete with Chinese imports in the United States and to sell their own exports in China.

    There is, however, another side to the story. The loss to American producers comes with a gain to the many millions of American consumers who prefer to pay less for the goods they buy.

    The situation is much the same as when the price of imported oil falls, as it has done in recent months. Domestic oil producers may see lower profits, but American consumers are better off every time they fill up their tanks. Consumers similarly gain when a cheap yuan reduces the prices of T-shirts and televisions imported from China.

    Mr. Geithner and other China critics might also want to ponder how the Chinese keep the yuan undervalued. The essence of the policy is supplying yuan and demanding dollars on foreign-exchange markets. The dollars that China accumulates in these transactions are then invested in United States Treasury securities.

    So when the Treasury secretary complains about the undervalued yuan, his message to the Chinese boils down to this: Stop lending us money.

    Not surprisingly, after Mr. Geithner made his remarks about the Chinese currency, the prices of Treasuries fell and yields rose. If China took him seriously, long-term interest rates would rise even more. As the United States embarks on a path of unusually large budget deficits, the nation’s chief financial officer should pause and think carefully before turning up the heat on one of its biggest creditors.

    Perhaps the oddest thing about Mr. Geithner’s move is that his complaint seems out of date. The yuan-dollar exchange rate has moved considerably in recent years. After a long period of completely fixing the exchange rate, China allowed its currency to start moving in July 2005. Since then, it has appreciated by 21 percent.

    Mr. Geithner might think that the yuan needs to move more, but why shine a bright light on the issue at this particular moment? Olivier Blanchard, the chief economist of the International Monetary Fund, had it right when he said: “It is probably not the right time to focus on the Chinese exchange rate, given that it is not a central element of the world crisis. There are many other things we should be thinking about.”

    DIRECTING attention to the China currency issue amid a worldwide recession and growing fears of depression is more than a distraction. It is downright counterproductive. Senators Charles E. Schumer, Democrat of New York, and Lindsey Graham, Republican of South Carolina, have long proposed dealing with the yuan undervaluation by imposing tariffs on Chinese imports. The Treasury secretary’s comments risk stoking those protectionist embers.

    Indeed, protectionist influences seem to be finding their way into the stimulus bill winding its way through Congress. The bill passed by the House included a provision banning the use of foreign iron and steel in infrastructure projects. The Senate has adopted a somewhat more flexible restriction (after voting down an amendment by John McCain to strip the “Buy American” provision from the bill).

    Despite having hired many first-rate economists with impeccable free-trade credentials, the president has been only tepid in his public opposition to this creeping protectionism.

    This may be a good time to recall the legacy of Senator Reed Smoot of Utah and Representative Willis Hawley of Oregon, both Republicans. The 1930 tariff bill that bears their name did not cause the Great Depression, but it contributed to a plunge in world trade and undoubtedly was a step in the wrong direction.

    As we sort through the wreckage of our own financial crisis, a retreat into economic isolationism is one mistake we want to be sure not to repeat.

    N. Gregory Mankiw is a professor of economics at Harvard. He was an adviser to President Bush.

  11. April 5th, 2010 at 16:21 | #11

    According to this China Institutes of Contemporary International Relations researcher, Liu Junhong, this desire by the U.S. to want “Yuan appreciation” is a short-term measure to maximize the benefits for the U.S. in a dollar-dominated international currency system:

    Due to Japan’s exports revival, foreign trade expansion and its growing surplus in its current account, the yen is currently under huge pressures for appreciation. The dollar’s lingering low interest rate against the yen has also pushed international funds to flow into Japan, adding to an appreciated yen. However, the equal foreign policy pursued by the Japanese Yukio Hatoyama government with the US has resulted in increasing frictions with Washington. An appreciated yen, in the eyes of Washington, would possibly squeeze the dollar’s space and accelerate its demotion to a US-based local currency. Under these circumstances, Washington believes it is its best choice to force China’s currency to revalue while acquiescing to the yen’s depreciation to strike a balance in the US-forged international currency system.

  12. April 7th, 2010 at 11:21 | #12

    Interesting perspective from Stephen S. Roach, chairman of Morgan Stanley Asia and author of “The Next Asia.” According to Prof Peter Nolan of Cambridge University, U.K., Roach predicted the financial collapse of the U.S.:

    “Stephen Roach has for many years been a uniquely independent voice among international economic commentators. He was one of the few who warned that the debt-fuelled ‘casino’ economy was unsustainable. His prophetic warnings came to pass in 2008.”

    China-bashing based on bad economics
    By Stephen S. Roach (China Daily)
    Updated: 2010-04-07 07:58

    The United States’ fixation on the “China problem” is now boiling over. From Google to the renminbi, China is being blamed for all that ails the US. Unfortunately, this reflects a potentially lethal combination of political scapegoating and bad economics that could end in tears.

    The political pressures are grounded in the angst of American workers. After over a decade of relatively stagnant real compensation and, more recently, a historically sharp upsurge in unemployment, US labor is being squeezed like never before. Understandably, voters want answers. It is all because of the trade deficit, they are told – a visible manifestation of a major loss of production and employment to foreign competition. With China and its so-called manipulated currency having accounted for fully 39 percent of the US merchandise trade deficit in 2008-09, Washington maintains that American workers can only benefit if it gets tough with Beijing.

    However appealing this argument may seem on the surface, it is premised on bad economics. In 2008-09, the US had trade deficits with over 90 countries. That means it has a multilateral trade deficit. Yet aided and abetted by some of America’s most renowned economists, Washington now advocates a bilateral fix – either a sharp revaluation of the renminbi or broad-based tariffs on Chinese imports.
    A bilateral remedy for a multilateral problem is like rearranging the deck chairs on the Titanic. Unless the problems that have given rise to the multilateral trade deficit are addressed, bilateral intervention would simply shift the Chinese portion of America’s international imbalance to someone else. That “someone” would most likely be a higher cost producer – in effect, squeezing the purchasing power of hard-pressed US consumers. Ironically, Washington’s penchant for the bilateral fix to a multilateral problem risks turning the tables on American workers just at a time when they are struggling to get back on their feet in this feeble post-crisis recovery.

    Instead of counterproductive China bashing, the US would be far better served if it took a deep look in the mirror and faced up to why it is confronted with a massive multilateral trade deficit. America’s core economic problem is saving and it’s not China.

    In 2009, the broadest measure of domestic US savings – the net national savings rate – fell to a record low of a -2.5 percent of national income. This is the sum total of depreciation-adjusted savings by households, businesses, and the government sector. Depreciation is removed to get a sense of how much savings are left – after providing for the normal obsolescence of antiquated or worn-out capacity- for the expansion of capital stock. In the case of the US, there isn’t any. That means the US must import surplus savings from abroad to fund the sustenance of its future growth.

    This is where China enters the equation. In order to attract the foreign capital that the US needs to sustain its growth, the US must then run a large current account deficit. In the case of the US, the cross-border multilateral trade deficit in goods and services has accounted for an average of 95 percent of the total current account deficit over the past five years. In other words, for a US economy without savings, there is no escaping large multilateral trade imbalances.

    Yes, China is the biggest piece of America’s multilateral trade deficit. But that is because high-cost US companies are increasingly turning to China as a low-cost offshore solution. And it also reflects the preferences of US consumers for low-cost and increasingly high-quality goods made in China. In other words, the US is actually quite fortunate to have China as a large trading partner.

    No, China is hardly perfect. Like the United States, it, too, has a large imbalance with the rest of the world – namely, an outsized current account surplus. And just as responsible global citizenship requires the US to address the savings deficiency that lies at the heart its international imbalances, the world has every reason to expect the same from China in reducing its surplus savings. Those adjustments must be the essence of any successful global rebalancing agenda.

    But these adjustments must be framed in the multilateral context in which the imbalances exist. Just as China is one of over 90 countries that the US runs trade deficits with, US-China trade now represents only 12 percent of total Chinese trade with the rest of the world. Consequently, it is wrong to fixate on the relative price between these two nations – specifically, the foreign exchange rate between the US dollar and the Chinese renminbi – as the solution for the deeply rooted savings disparities that drive these multilateral imbalances.

    Yet some of America’s most prominent economists are saying the opposite – claiming that a revaluation of the renminbi vis–vis the dollar would not only create over one million jobs in the US but that it would inject new vigor into an otherwise anemic global recovery. Economists should know better. Changes in relative prices are the ultimate zero-sum game – they re-slice the pie rather than expand or shrink it. When nations have large imbalances with a large cross-section of their trading partners – as is the case with both China and the US – there can be no bilateral solution.

    Currency, or relative price, adjustments between two nations are not a panacea for structural imbalances in the global economy. What is needed, instead, is a shift in the mix of global savings. Specifically, the US needs deficit reduction and an increase in personal savings, while China needs to stimulate internal private consumption.

    Washington’s scapegoating of China could take the world to the brink of a very slippery slope. It wouldn’t be the first time that political denial was premised on bad economics.

    But the consequences of such a blunder – trade frictions and protectionism – would make the crisis of 2008-09 look like child’s play.

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