The Chinese economic boom could change the global order and lift Beijing above Washington in economic might and influence. The United States is worried about China's tactic of undervaluing its currency to boost exports, but Beijing has resisted repeated calls to raise the yuan's value. The result has been a boost for U.S. consumers buying low-cost Chinese goods, as well as what some say is a severe trade imbalance. In addition, the overheating of the Chinese economy would have worldwide repercussions. The U.S. Congress has entertained threats of trade retaliation, but administration policymakers have adopted a more cautious approach.
Stephen Roach, chief economist and director of global economic analysis at Morgan Stanley, and Desmond Lachman of the American Enterprise Institute debate the seriousness of the challenge posed by China and appropriate steps to respond to its rise.
October 13, 2006
China Does Have the Means to Balance Its Economy
Stephen Roach appears to be very much more pessimistic than I am about China’s ability to reduce its unusually large current account surplus in a timely manner. He takes the view that China’s particular circumstances as a blended economy render ineffective both conventional macro-stabilization policies and the use of the exchange rate.
If Stephen were right on this count, a train wreck in China’s trade relations with Europe and the United States would only be a matter of time. Meaningful protectionist measures against China have already surfaced in the U.S. Congress in response both to China’s very large trade surplus and to the downward pressures on wage growth stemming from the integration of China’s large labor force into the global economy. Protectionist pressures can only be expected to intensify should China’s payment surplus persist, especially were there to be a global economic slowdown. China is presently making a grave mistake in underestimating the risk of a protectionist backlash and in ignoring earlier sad historical precedents of the integration of large countries in the global economy.
Fortunately, there is little evidence to support the view that China does not have the means to reduce the level of its domestic savings and to wean its economy from its overdependence on a widening trade surplus. Experience in many countries would suggest that over time China could appreciably reduce its unusually high savings rate, which now is around a staggering 50 percent of household income. It could do so by supplementing the use of conventional monetary and fiscal policy with the elimination of the many underlying market imperfections that presently result in China’s very high rate of precautionary savings. To that end, China might introduce a more robust retirement system, provide better health insurance, strengthen property rights that would lead banks to lend less on collateral and more on projects, and develop private insurance.
While China is indeed a mixed economy, the large part of its economy engaged in external trade is responsive to price signals. As such, there is little reason to doubt that meaningfully moving the exchange rate would over time have the desired effect of discouraging exports and encouraging imports in much the same way as it has done in many other transitional economies.
Where I do fully agree with Stephen is that the United States must refrain from using China as an excuse not to get its own house in order. Any orderly resolution of today’s global payment imbalance problem must require that the United States takes early measures to improve its dismal savings performance. It should do so at the same time that China takes measures to redirect its economy away from the export sector and towards domestic demand.
October 12, 2006
Currency Fix Is the 'Wrong Medicine'
Desmond’s recommendation for “significant and early movement in China’s exchange rate” is a classic textbook prescription for fixing a large current account imbalance. Unfortunately, China is far from a classic textbook economy—making the currency fix the wrong medicine at the wrong point in time.
Despite twenty-seven years of extraordinary reforms, China is still very much a blended economy. Notwithstanding the emergence of a thriving market-based sector, state-owned enterprises still account for about 35 percent of Chinese GDP. Moreover, China is not a centralized, well-integrated macro system. Power still resides mainly in provincial, city, and village governments—making it very difficult for Beijing to steer the nation as a whole. The banking system is equally fragmented. As recently as late 2004, the four biggest banks collectively had over 75,000 branches—most of which have autonomous deposit-gathering and lending capabilities.
A blended and fragmented Chinese economy cannot be effectively controlled by conventional macro stabilization policies. Beijing can pull the fiscal and monetary levers but there’s no telling what the response will be. Unfortunately, what Desmond misses is that the same is true of currency policy.
Over the past decade, China’s exports have increased by six-fold. Yet fully 63 percent of that increase can be accounted for by “foreign-invested enterprises” —Chinese subsidiaries of foreign multinational corporations and joint ventures. In other words, the power of the Chinese export machine is mainly an outgrowth of a Western penchant for offshore efficiency solutions.
Moreover, since the mid-1990s, China’s imports have quintupled—driven increasingly by demand for manufactured components from its Asian neighbors. This reflects China’s role as the world’s assembly plant—a very different function than that of the manufacturing behemoth the protectionists believe is gaining unfair advantage because of a cheap currency. In short, courtesy of globalization, China has experienced explosive growth on both sides of the foreign trade ledger. Can we truly expect a currency fix to stop cross-border economic integration dead in its tracks?
This debate touches many of America’s economic hot buttons—subpar job growth, near stagnation in real wages, deficit financing, and the hollowing out of smokestack industries. These are critically important issues that the U.S. can no longer duck. Historically, our greatest strength as a nation has been to look inside ourselves and rise to the competitive challenge. The scapegoating of China is antithetical to that greatness.
I am deeply troubled that discussions of U.S.-China trade issues always come back to what we in America think China is doing wrong. China is far from perfect and must accept greater responsibility for its role in trade disputes—especially with respect to intellectual property rights. But there’s a limit to what can be expected from China and a lot more we can ask of ourselves.
October 11, 2006
Current Deal Delays United States' 'Day of Reckoning'
Stephen mischaracterizes my view as condoning U.S. inaction on its budget deficit problem while pressing China for immediate currency action. To be clear, my view is that resolution of today’s global payment imbalances will require both (a) an early and credible medium-term U.S. deficit reduction program and (b) significant and early movement in China’s exchange rate. More substantive Chinese currency action is required not simply to address China’s extraordinarily large current account surplus, but it is also needed to facilitate a more generalized appreciation of other Asian currencies.
Stephen condones China’s paltry 2 percent currency appreciation over the past fifteen months at a time when China’s very large basic balance of payment surplus would suggest that its currency is undervalued by around 20 percent. He rationalizesChina ’s currency inaction on the grounds that China ’s fragile banking system could not tolerate a greater degree of currency movement. He makes this argument even though the Chinese banking system does not have any significant currency mismatch between its assets and liabilities. He also does so knowing full well that if meaningful currency movement awaits the restoration to health of China’s chronically undercapitalized banking system, we will be waiting for many years to come.
To question, as Stephen does, whether a greater degree of currency movement is in China’s best long-term interest is misguided for at least three reasons: First, without a greater degree of currency movement, together with measures to encourage domestic consumption, China will continue to run unacceptably large external current account surpluses. This will almost certainly invite damaging protectionist pressures against Chinain both Europeand the United States, especially in the event of a global economic downturn. Second, in the absence of greater currency flexibility, China’s central bank’s scope to use interest-rate policy to regulate the economy will continue to be highly limited by the unwanted capital inflows that higher interest rates would attract. This will make it difficult for China to avoid the type of overinvestment cycles and speculative excesses that it is presently experiencing, which in the end will further weaken China’s rickety banking sector. Third, China’s de facto pegging of its exchange rate requires that the Chinese central bank engage in costly foreign exchange intervention to the tune of a staggering $250 billion (in U.S. dollars) a year. The dollars the central bank buys at an overvalued dollar rate could end up costing China as much as 2 percentage points of GDP each year.
Stephen is, of course, right in suggesting that the United States presently has a good deal going for itself by having China send goods to the United States in exchange for dollar pieces of paper. The trouble with this deal, however, is that it dangerously increases China’s financial leverage over the United States and it only delays the United States’ day of reckoning for presently living well beyond its means.
October 10, 2006
Beijing Not Ready for Reform
Like all disputes, there are two sides to the U.S.-China trade debate. What concerns me is the one-sided nature of this dispute. Desmond Lachman’s argument is classic in that regard—as is that of the Washington Consensus [standard economic reform package promoted by neoliberal economists]. To paraphrase: Sure, we in America need to fix our deficits—and maybe some day we will—but China needs to get its act together now.
A stronger RMB [yuan] may seem to be in our interest—although I have my doubts, as noted below. But it may well be that a currency revaluation is simply not in China’s best interest at this point in time. The reason: China has an undeveloped financial system. Its banks are only just starting to go public and its capital markets are tiny by our standards. Currency fluctuations could, as a result, place great strain on the Chinese financial system at a critical juncture in its economic development. We may not accept that logic, but at least we need to consider the possibility that China may know a good deal more about the inherent risks in its financial system than we do.
This may be nothing more than a sequencing problem. Financial reforms may not have gone far enough in China to allow it to cope with the stresses and strains that might arise from sharp currency fluctuations. China is committed to the long-run objective of a flexible currency, and as Desmond notes, has taken some small steps in that direction. It has been very frank in admitting that it needs to go much further. Linking the timetable to a broader financial market reform agenda seems like a very prudent course of action.
Even if Washington were to get its way, it might end up being very disappointed over what little would be accomplished by a sharp revaluation of the Chinese currency. America’s gaping trade deficit is, first and foremost, an excess import problem. In the second quarter of 2006, U.S. merchandise imports were fully 84 percent larger than exports. This voracious appetite for foreign-made products is an outgrowth of an unsustainable consumer-buying binge—personal consumption has surged to a record 71 percent of GDP while personal savings has fallen into negative territory for the first time since 1933. A revaluation of the RMB—unless it was of a draconian magnitude—would do next to nothing to curtail excess consumption and reduce America’s import-led trade deficit.
None of this is to argue that China shouldn’t work harder to reduce its large trade surplus. As I noted in my opening comment, it needs to do much more in preventing the piracy of intellectual property. And China also must stimulate its own consumer in order to boost purchases of foreign-made goods—actually, a goal that was underscored in its recently enacted eleventh Five-Year Plan [for economic and social development]. But just as America needs time to get its deficits under control, China needs time on the reform front. Sadly, that’s the other side of the story that Washington doesn’t want to hear.
October 10, 2006
China Must Play by the Rules of the Game
Stephen Roach is certainly right in drawing attention to the important role that improved U.S. savings performance must play in addressing today’s record payment imbalances and in improving U.S. labor market performance. However, he is very wide of the mark in turning a blind eye to China’s pursuit of flagrantly mercantilist policies and to its deliberate manipulation of its currency to gain an unfair competitive advantage.
Today’s unprecedented large global payment imbalances raise the very real risk of intensifying protectionist pressures that could in time undermine the world’s trading system. This calls for the orderly correction of the large U.S. current account imbalance, which in turn will require both a reduction of U.S. domestic expenditures as well as a switching of global expenditures toward the U.S. traded goods sector.
In proposing that the United States substantially improve its savings performance, Stephen Roach is focusing on only the expenditure reduction part of the solution to the U.S. external deficit problem. However, if the United States is to correct its external deficit, while at the same time avoiding a deep recession, it will need not only a higher level of domestic savings but it will also need a much cheaper dollar to promote its exports and to discourage its imports.
China now pays lip service to the need for a more appreciated Chinese renminbi [Chinese currency consisting of yuan] as part of the solution to the global payment imbalance problem. In July 2005, China did appreciate its currency by 2 percent and it committed itself to a more flexible currency policy. Over the past fifteen months, however, nothing much has changed. China has only allowed a further 2 percent appreciation in its currency and it still, in effect, pegs to a depreciating dollar, which keeps its currency grossly undervalued by any reasonable measure.
The net upshot of China’s currency manipulation is that China has now become the world’s largest surplus country and the world’s largest holder of foreign exchange reserves. China’s current account surplus has already surpassed that of Japan and it is on the way to exceeding $250 billion (in U.S. dollars), or 9 percent of its gross domestic product (GDP), in 2007.
In short, I fully agree with Stephen Roach that the United States should not simply scapegoat China and should address its own serious savings problem. However, if we are to avoid a train wreck in the global trading system, China should start playing by the international rules of the game and stop manipulating its currency. It should do so in both its own long-run interest and in that of the global economy.
October 9, 2006
Don't Scapegoat China
China has become the scapegoat for one of America’s toughest economic problems. Workers and their elected representatives are understandably concerned about the persistence of subpar job growth and a decade of nearly stagnant real wages. With these pressures occurring in the midst of a record foreign trade deficit and with China accounting for fully 25 percent of that imbalance, the blame game is on. Since the beginning of 2005, fully twenty-seven pieces of legislation have been introduced in the U.S. Congress that would impose punitive actions on China for engaging in unfair trading practices with the United States.
While I certainly think Washington needs to be tough in its trade negotiations with China—especially in the area of intellectual-property rights—I fear the politicians don’t get it. The U.S. trade deficit—to say nothing of the Chinese piece of this deficit—has not come out of thin air. It is a reflection of our inability to face one of our biggest economic shortcomings as a nation—a dearth of domestic saving. In 2005, America’s net national saving—the combined saving of individuals, the government, and the business sector net of depreciation—fell to a record low of just 0.1 percent of national income. Lacking in domestic saving, the United States must import surplus saving from abroad in order to grow—and run massive current-account and foreign trade deficits to attract the capital.
With the current account deficit running at an $870 billion annual rate in the second quarter of 2006, the United States needs about $3.5 billion of foreign capital each business day. The fact that the biggest portion of our trade deficit is with China is actually a good thing—it provides Americans with low-cost, high-quality products. If Washington were to get its way and raise the cost of doing business with China, that would be the functional equivalent of a tax on the American consumer. Barring an increase in national saving—namely, a cut in the government budget deficit and a boost to personal saving—the trade deficit would not go away. Instead, it would simply be directed toward a higher-cost producer elsewhere in the world. And China, for its part, would probably think seriously about its strategy of buying Treasuries [government securities] and other dollar assets—putting pressure on the dollar and U.S. interest rates.
It’s time to stop blaming China for what ails us and look in the mirror. If we don’t get our own house in order and start saving more as a nation, the scapegoating of China could end up being a policy blunder of monumental proportions.