SERIOUS MONEY:THE EURO zone's internal contradictions were removed from the spotlight last weekend, as the focus returned to global imbalances upon China's announcement that it intends to gradually relax the peg between the renminbi and the dollar, writes CHARLIE FELL
The Middle Kingdom’s decision to return to the arrangement that was suspended at the height of the global financial crisis during the summer of 2008, has been taken ahead of the G 20 summit in Toronto, and should serve to ease strained Sino-American trade relations.
China’s exchange rate policy has been a matter of considerable political debate in the US and could be used as a platform for votes in the upcoming midterm elections. Nobel laureate Paul Krugman has thrown his intellectual weight behind the debate, and has argued that the Middle Kingdoms “policy of keeping its currency, the renminbi, undervalued has become a significant drag on global economic recovery. Something must be done”.
C Fred Bergsten, of the Peterson Institute for International Economics, has rallied behind Krugman and both suggest China’s exchange rate policies are “protectionist”. They believe the renminbi needs to appreciate by roughly 25 to 40 per cent against the dollar to correct the problem. However, their analyses may be wrong, in which case, they should be careful what they wish for.
The tone of the criticism is remarkably similar to the commentary that accompanied the growing frustration with the expanding US trade deficit through the 1970s and 1980s. Germany and Japan were the supposed culprits for America’s ills in the early 1970s, and criticism of their export-led growth was all too evident in the Nixon administration. Japan was the noted trade villain throughout the 1980s, but even the sharp appreciation of the yen following the Plaza Agreement in 1985, did little to improve the US trade position.
The pattern of international trade is far more sophisticated today, and it is unclear whether a significant appreciation of the renminbi would do more harm than good to US interests.
China’s influence on the world economy has increased enormously since its accession to the World Trade Organisation towards the end of 2001.
Its current account surplus grew from under 3 per cent of GDP in 2003 to over 11 per cent of GDP at the 2007 peak, and was almost 6 per cent last year, despite a sharp drop in exports.
Krugman and Bergsten believe the competitive exchange rate has caused substantial job losses in the US and will continue to do so in the future if current policy goes unchallenged. Indeed, the former estimates that, if the status quo prevails, roughly 1.4 million jobs will be lost in the years ahead, while Bergsten reckons that the required trade adjustment would create an additional 600,000 to 1,200,000 jobs. Krugman and Bergsten’s analyses, however, fail to account for the fact that China’s emergence as the manufacturing workshop of the world has positioned the Middle Kingdom at the centre of a complex global supply chain for tradable goods.
The country’s rise as an export platform has been accompanied by a surge in imports from its Asian neighbours, as it sources goods for further processing and eventual re-export to the developed world. Furthermore, US exporters source competitively-priced components from the Middle Kingdom and retain the additional value added once the goods are sold in international markets. Thus, a significant appreciation of the renminbi would not work quite as neatly as envisioned by the critics.
Indeed, such an action could depress growth throughout East Asia, and importantly, from a US perspective, result in the loss of American jobs.
The timing of the escalating criticism of China’s exchange rate policy is also difficult to comprehend. The global financial crisis and the subsequent collapse in international trade forced the Chinese, albeit belatedly, to reconsider their export-led growth model. Unprecedented monetary and fiscal stimulus measures allowed China’s economy to recover more rapidly than others from the “great recession”, with growth finishing 2009 at almost 9 per cent.
It could well be argued that no other country did as much to pull the world out of its economic malaise. US exports to China are already 20 per cent above pre-crisis levels. Perhaps the intellectual heavyweights should be applauding rather than criticising China’s efforts.
China’s decision to introduce more flexibility into its exchange rate regime is a welcome development ahead of the weekend’s G 20 summit in Toronto, but trade tensions are unlikely to disappear anytime soon given the midterm elections in the US later in the year. The pro-jobs argument espoused by China’s critics may well win votes, but a closer analysis of international trade and its complex web of bilateral relationships, suggests that a significant appreciation of the renminbi could in fact contribute to higher unemployment. The critics should be careful what they wish for.
www.charliefell.com
