Friday, November 27, 2009

China Currency Debate Continues, But Should It?

U.Chicago's Gary Becker and Richard Posner have on their blog a must-read exchange re: China currency and who ultimately benefits/suffers from it.  The whole thing is worth reading, but before discussing the nitty-gritty highlights, the debate's mere existence is important and noteworthy.  That reasonable, very smart minds still differ about the China currency conundrum and its effects should make everyone very, very suspicious of various' partisans dogmatic sermons on the evils of China's currency "manipulation" and its myriad harms for the US economy. Obviously, this issue is not as open-and-shut as the finger-pointing yellers in Washington want us to believe.

Now back to the actual substance of the very-smart-guys' blog entries. First (alphabetically), is Becker who, after dispatching with some recent history of Chinese efforts to keep the RMB artificially low, explains why he thinks that China's policies actually benefit, in the aggregate, the United States and harm China:
[I]n good part due to the low value of its currency, China has run substantial surpluses on its current trade account as it imports fewer goods and services than it exports. The result is that China has accumulated enormous reserves of assets in foreign currencies, especially in the form of US government assets denominated in dollars. As of September of this year, China had the incredible sum of over 2 trillion dollars in foreign currency reserves, such as US Treasury bills. This is by far the highest reserve in the world, and it amounts to the enormous ratio of more than one quarter of China's GDP of about $8 trillion (purchasing power parity adjusted).

I am dubious about the wisdom of both America's complaints about China's currency policy and of China's responses. On the whole, I believe that most Americans benefit rather than are hurt by China's long standing policy of keeping the renminbi at an artificially low exchange value. For that policy makes the various goods imported from China, such as clothing, furniture, and small electronic devices, much cheaper than they would be if China allowed its currency to appreciate substantially in value. The main beneficiaries of this policy are the poor and lower middle class Americans and those elsewhere who buy Chinese made goods at remarkably cheap prices in stores like Wal-Mart's that cater to families who are cost conscious.

To be sure, US companies that would like to export more to China are hurt by the maintenance of the Chinese currency at an artificially low value relative to the dollar. As a result, employment by these companies is lower than it would be, so that this may contribute a little to the high rate of US unemployment. But I believe the benefits to American consumers far outweigh any loses in jobs, particularly as the US economy continues its recovery, and unemployment rates come back to more normal levels.

Since the opposite effects hold for China, I cannot justify their policies from the viewpoint of their interests. Their consumers and importers are hurt because the cost of foreign goods to them is kept artificially high. Their exporters gain, but as in the US, that gain is likely to be considerably smaller than the negative effects on the wellbeing of the average Chinese family.

I reach similar conclusions about China's accumulation of their excessive reserves. The US has little to complain if China wants to hold such high levels of low interest-bearing US government assets in exchange for selling goods cheaply to the US and other countries. China's willingness to save so much reduces the need for Americans and others to save more, but is not differences in savings rates also part of the international specialization that global markets encourage? To be sure, why China is willing to do this is difficult to understand since they are giving away goods made with hard work and capital for paper assets that carry little returns.

One common answer is that China hopes to increase its influence over economic and geo-political policies by holding so many foreign assets. Yet it seems to me just the opposite is true, that China's huge levels of foreign assets puts China more at the mercy of US and other policies than visa versa. China can threaten to sell large quantities of its US Treasury bills and other US assets, but what will they buy instead? Presumably, they would buy EU or Japanese government bills and bonds. That will put a little upward pressure on interest rates on US governments, but to a considerable extent, the main effect in our integrated world capital market is that sellers to China of euro and yen denominated assets would then hold the US Treasuries sold by China.

On the other hand, the US can threaten to inflate away some of the real value of its dollar denominated assets-not an empty threat because of the large US government fiscal deficits, and the sizable growth in US bank excess reserves. Inflation would lower the exchange value of the dollar, and also of the renminbi, as long as China keeps it tied to the dollar. That would further increase the current account surpluses of China, and thereby induce China to hold more US and other foreign assets, not a very attractive scenario to China....
This seems quite right to me.  First, Becker's comments on China's debt holdings being a problem for China echo those of Dan Drezner, and I also find this angle compelling.  And Becker's certainly right about the benefits of low-cost Chinese imports for lower-income and cost-conscious American families.  It's basically a big tax cut for the Wal-Mart crowd. 

But Becker leaves out a very important point: the other "major beneficiaries" of China's currency policy are the many US manufacturers that use low-cost Chinese inputs (steel, etc.) to produce globally competitive downstream products.  Afterall, about 55% of all US imports are capital goods and equipment (i.e., industrial inputs), so it's not just lower-income American consumers that benefit from low-cost imported products (although they certainly do too).  Because of this import distribution and China's currency policy, import-consuming US industries' revenues and employment levels are significantly higher than they would be if China appreciated the RMB.  Indeed, as I noted about a week ago, the Congressional Research Service explained this fact in a 2009 report when it forecast that aggregate US employment wouldn't change much if China appreciated its currency - it would just shift from import-consuming industries to export industries.  So China's currency policy is actually more beneficial to the United States than even Becker leads on.

Now on to Posner, who disagrees with Becker and thinks that China benefits from its "mercantilist" currency policy, and that the US is on the losing end.  But the "harm" that Posner points out is not what you would think - or that the protectionist dogmatists in Congress (and elsewhere) want us to believe:

Could China have sensible reasons for such an odd, old-fashioned policy ("mercantilism"--the maximization of a nation's cash or cash-equivalent reserves--famously attacked by Adam Smith more than two hundred years ago)? It could. The immense exports that China's skewed exchange policy has fostered provide employment for a large number of Chinese. Their wages are low, but at least they have jobs. Of course they might have jobs if the dollar were cheaper relative to Chinese currency. China would import more and export less. It would manufacture less, because many workers would be required for the expanded system of domestic distribution that would be necessary if domestic consumption (both of Chinese manufactures diverted from export to internal markets and of imported goods). It would manufacture a different mixture of goods, because of competition from imported goods, but above all it would need a much more elaborate system of wholesale and retail distribution, and perhaps a different commercial culture. The transition to a modern consumer society with its credit cards and product warranties and malls and the rest would be difficult. In the interim there might be widespread unemployment; shifting employees from manufacturing to distribution, or from one type of manufacturing to another, doesn't happen overnight. And China doesn't have the kind of social safety net that we do, to catch the unemployed before they reach the bottom. Because of the limitations of domestic consumption, Chinese are great savers, and this relieves the pressure the government would otherwise feel to provide social services. That provision might strain the government's administrative abilities.

China has a long history of political instability, and there is tension between its dictatorial communist government and its largely free-enterprise economy. It is naturally reluctant to take chances on changing its economy from one of producing manufactured goods for export to one of manufacture and distribution primarily for domestic consumption....

Would we benefit from China's abandoning mercantilism? As Becker points out, our consumers benefit from the artificially low prices at which Chinese goods are sold in this country. At the same time, our dependence on China's financing our public debt weakens our ability to influence Chinese policy on issues of urgent concern to us, such as the threat of nuclear proliferation posed by North Korea, Iran, and Pakistan, and the need to take effective steps to limit global warming.

Then too it seems that the only way in which we can buy those cheap goods from China is to borrow from China. We buy more from China than we sell to it and so China accumulates dollars to bridge the gap, dollars that it then lends to the U.S. Treasury. The effect is to reduce pressure on our government to pay down our immense and growing public debt either by raising taxes or by cutting spending.
While I disagree with Posner that China's debt holdings necessarily reduce US influence on key policy issues, and think (again) he misses the big benefits that US manufacturers (and their workers) reap from low-cost Chinese inputs, his final point - i.e., that the present China currency policy reduces the federal government's need to get its own fiscal house in order - is interesting and deserves discussion.  It is true that the Feds have in China a "whale" - a willing buyer of US debt, even as it becomes increasingly diluted.  But I'm skeptical that a significant deceleration of China's debt purchases would affect the current government's insatiable desire for expansion through spending.  Just consider recent events: China's US debt holdings have plateaued (actually decreasing slightly) in the last few months, and the US budget deficit for 2009 was announced to be a staggering $1.4 trillion (about 10% of GDP).  Yet the response of Congress and the Obama adminstration has been to steamroll a multi-trillion dollar debt-bomb in US healthcare "reform" (yet another huge expansion of our already-broken entitlement system), and to contemplate untold billions on a second/third stimulus"jobs bill."  Such federal "responses" sure seem to indicate that our bloated government's fiscal profligacy is less the result of external forces like China's currency policy and far more the result of political entrenchment, manipulation and mismanagement (and, of course, a wholly complicit electorate).

Thus, it appears that only a groundswell of electoral opposition to (admittedly bipartisan) federal spending stupidity will prevent a debt-induced economic collapse (i.e., inflation, high interest rates, unemployment, economic stagnation, etc.).  Revaluing China's currency will only make the collapse happen more quickly.  In other words, the only thing that will keep America's fiscal freight train from going over the cliff is to pull the emergency brake, not to move the cliff closer to the oncoming train.  I respect Posner a lot, but unless I'm missing something, his version of "starve the beast" doesn't seem to mesh with recent reality (or Washington unreality).

These disagreements aside, Posner's other point seems the most important from a practical perspective: the institutional structure of the Chinese economy/society would prevent any quick and significant change in China's current mercanilist growth model, regardless of whether China let the RMB float.  And it will take many years for this structure to change.  In this way, Posner's comments argue strongly against a US policy of demanding RMB appreication in order to quickly "rebalance" the US-China trade deficit.  It just can't work in the short term, as the 2006-2008 RMB appreciation proved.  Instead, China needs to continue its slow transition from a system predicated on export-led growth to one driven by domestic consumption and featuring a proper institutional framework.

And US politicians (and pundits) need to back off the currency talk and turn their pointy little fingers inward.

(Yeah, like that'll ever happen.)

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