Monday, January 11, 2010

China and the dollar

China has called upon the US to redress "global imbalances" by spending less and saving more. This is part economics and part politics. The Asians want to put the US on the defensive because of our twin deficits, both of which they are financing involuntarily. They want to be able to lecture us, after all of the unwanted "advice" coming out of Washington over the years.

But their arguments are entirely one-sided. The deficit countries (us) have to make all the adjustment. The surplus countries don't have to do anything because "exchange rate appreciation of surplus country currencies has not proven to be effective in adjusting current account imbalances" which is true only at the margin. Freely floating exchange rates will over time result in balanced trade. But the RMB doesn't float; it is pegged to the dollar--by them, not by us.

The Chinese want us to pursue sound policies that will support a strong dollar in relation to other currencies: in other words, we should peg to the world instead of vice-versa. All the adjustment should occur in the US. The exchange-rate value of the dollar should be an objective of US monetary policy. 

The Chinese are right that we need to spend less and save more. But the way to get there is not an exchange-rate anchor. Such an anchor requires extraordinary national discipline and consensus that the external value is more important than growth or inflation/deflation. Hong Kong has been able to do it because it is not a democracy, and the dollar peg is supported by consensus.

If China is so unhappy about US economic policies, all they have to do is to unpeg the RMB from the dollar and peg to something else (the SDR, the euro, the yen, a basket) or float, which is what both Japan and Korea have done. But they havn't done this. Why? Because the US is the Importer of First and Last Resort, and they want their products to be cheap in US$. They want us to run a big trade deficit so they can fill it with their goods. They are classic mercantilists, except the mercantilists accumulated gold while the Chinese collect (depreciating) paper dollars.

There is no such thing as virtue in international financial relations, only self-interest. The Chinese aren't bad nor are we. We are all acting in our own self-interest. The G-20 will call on the US to balance its budget (which we should) and on the Chinese to appreciate the RMB (which they should). China and the US will do as they please. China will threaten to sell dollars, which they won't. The US will put tarriffs on Chinese products, but not enough to deprive us of what we want to buy. Nothing will change. Ten years from now the Asians will own a mountain of Treasuries, but that won't force a change.

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