from Follow the Money

I must be the least dovish of all China doves …

May 11, 2006

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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I have been quoted rather extensively in the past few days on Treasury’s foreign exchange report –

And in this debate, you are either a dove or a hawk.   Doves (Roach) don’t think that the US should have named China as a manipulator.   Hawks (Goldstein, Morici) think the Treasury wimped out, and failed to call out China’s obvious manipulation.  

And that puts me in the uncomfortable position of being a dove.

Not because I support China’s peg.   Regular readers know that I think that China’s peg  is a huge impediment to global adjustment.    Not the only barrier, to be sure.   The US current account deficit of  $1 trillion exceeds even China’s considerable capacity to mobilize its domestic savings to lend to the US – it truly is a global problem.   And I think most readers know that I clearly don’t think it is in the United States’ long-term interest to have an economy that specializes in the production of debt for sale to China’s central bank.

But rather because I doubt that calling China a manipulator will lead China to stop manipulating.  


I think that there is meaningful chance that China will move more over the summer in the absence of a formal declaration of manipulation and a meaningful risk that it might refuse to move at all if the US found it guilty of manipulation, just to prove that it won’t move under pressure.

I also believe that the multilateral process for putting pressure on China through the IMF deserves a chance.

Which does mean that I end up defending a Treasury report that denies the obvious. 

China’s intervention has been massive, one-sided and, by preventing appreciation in the face of China’s rising current account surplus, an impediment to global adjustment.

I suspect tomorrow’s report on March trade will provide more evidence to that effect; personally, I suspect the March deficit will top $67 billion.  All of China's exports in March had to go somewhere, and the ports data suggested a decent fraction ended up on America's west coast.

I also – unlike many – think the criteria in the Treasury report leave open the option of naming China a manipulator in the fall, assuming that Congress hasn’t changed the law before then.  Indeed, if China doesn’t move, I suspect the Administration will have to do something or the Congress will.    Both the Congress and the Administration have an incentive to show their high cards just before the election.

Finally, I do think that you need an exit strategy before you rush into something.  

Declaring China guilty of manipulation in some sense wouldn’t change anything.   A finding of manipulation just requires formal negotiations, nothing more.   On another level, though, it changes everything.   The US would have effectively declared the current international monetary and financial system – what Dooley, Garber and Folkerts-Landau call the revised Bretton Woods system – illegimate.   The intervention central to this system – and central to the financing of the US, despite the Treasury’s some lame attempt to show that most flows coming into the US are private in the body of the report – would be declared to be “manipulation.”   Nothing has changed, yet everything would seem different.

That seems rather risky when it is clear that the US has a policy of pushing China to appreciate, but no real policy to addresss its long-term fiscal problems.  The President’s priority is big tax cuts for those on top, those who have benefited disproportionately from the financial flows associated with China’s peg – not putting the US government’s finances on a sound long-term basis.   

That increases the risks of naming China a manipulator.  One of the things that China is manipulating is the Treasury’s borrowing costs.

What of Roach’s argument that China’s peg isn’t a barrier to adjustment – or, to put it differently, the US should be thanking China for providing it with both cheap goods and cheap financing to buy those goods, not complaining of manipulation.

I don’t buy it.

Roach makes two arguments. 

First, Roach argues that China is taking steps to reduce its current account surplus, and, implicitly, argues that those steps will work in the absence of further moves in the RMB. 

However, I think the available evidence suggests that China continues to invest overwhelmingly in the production of tradable goods – and in moving up the value-added chain – despite the government’s calls for rebalancing.   The price signals sent by the exchange rate – and by a host of other distorted prices – work against changing the basis of China’s growth.   Read the latest World Bank Quarterly.

Nor is there much evidence that China is willing to allow its real exchange rate to appreciate through high rates of domestic inflation – an alternative adjustment mechanism.   Inflation in China – for reasons that I don’t fully understand – is heading down not up, and remains well below US inflation.   Inflation differentials are making China more competitive, not less.

Second, Roach argues that exchange rate moves won’t matter so long as the US is so short of savings.   I disagree there too.   I think the current system of pegged exchange rate that ties the currencies of most surplus countries to the dollars is a big reason why the US can obtain the financing it needs to sustain low savings rates.   And so long as Asian central banks (and the oil exporters) provide the US with a credit line, financing the US when others don’t want to (i.e. now), neither the US consumer nor the US government has much incentive to cut back.  I would rather the US start to cut back before our creditors force us to, but if our credit line got cut, we would have to respond.

From June 2004 to June 2005, China’s government bought $180b of US debt.   That’s huge.  Without Chinese financing, the US wouln’t be able to finance the huge deficits associated with its low, low levels of national savings.   

Nor do I believe that production would just shift elsewhere in Asia , as Roach often suggests.   In 2006, the US will import $300b of goods assembled in China.    And China will have built capacity to assemble even more.   That amount of production – and the entire supply chain and logistics path that goes with it – cann’t migrate to Vietnam over night.  And if it did migrate to Vietnam, the scale of the resulting capital inflow would push up Vietnam’s exchange rate.  Unless Vietnam’s central bank decided to emulate the People’s Bank of China.

A bit of RMB appreciation would also help to slow the flow of FDI into China – i.e. make GM and Ford and others think twice before the source all auto parts from China.

I also think the evidence is reasonably good that Chinese exports are responsive to price changes.  Remember, exports were about 20% of China’s GDP until 2002.   Then they started to shoot up.  What happened in 2002?   The dollar started to fall against a broad swath of currencies, a process that accelerated in 2003 and continued in 2004, before partially reversing itself in 2005 (and then resuming in 2006).   The result?  A boom in Chinese exports, a surge in China’s exports to GDP ratio and an enormous increase in Chinese investment in tradables production …

Somehow, I find it hard to believe that these changes were not at least partially the product of China’s peg …

I am hardly a dove.  And I promise, I won’t write more about “manipulation” until later this summer.

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