from Follow the Money

Self promotion watch (Treasury foreign exchange report edition)

May 10, 2006

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I was interviewed by Adam Davidson of NPR about the Treasury’s forthcoming foreign exchange report (to be released at 4 pm today). You can hear the results here.    Adam Davidson also interviewed the person actually making policy, Tim Adams. 


Adams didn’t give any hints about what he plans to say in tomorrow report.  If I had to bet, I would say that the Treasury will not name China as a manipulator.    That seems to be the current market consensus


For me, it is a very close call but, on balance, I also think giving China a bit more time would be the right move.  In part because there are multilateral approaches that might work.  But I am not that far behind Fred Bergsten either


Update: The Treasury was "unable to determine ... that China's foreign exchange system was operated during the last half of 2005 for the purpose (i.e. with the intent) of preventing adjustment in China's balance of payments or gaining China an unfair competitive advantage in international trade.  Thus the technical requirements for China to be designated under the terms of the Act have not been met."


More in a bit.  I think the key phrase is "during the last half of 2005."   China has been communicating with the US by holding the RMB above 8 over the past few weeks.  The phrase "last half of 2005" is the United States' Treasuries response. 



China certainly meets the technical criteria for currency manipulation.  China’s currency intervention has an impact on the composition of US output, favoring some sectors over others.  The latest Treasury data suggests that between June 2004 and June 2005, China bought something like $180b of US debt.  It bought maybe $50b of US goods over that period.  That has an impact. China’s continued peg also is an impediment to effective balance of payments adjustment.    Martin Wolf nicely explains why currency adjustment should play a role in reducing the US trade deficit.  Global adjustment will be hard if the biggest surplus countries tie their currencies to the dollar -- the currency of the biggest debtor country.


At the same time, I do worry about how any decision to name China as a manipulator would play in China.   I don’t think that China has demonstrated that it will move without any international pressure.  China kept missing chances to get off the peg in 2003 and 2004, when the US was very quiet.  But if the US names China as manipulator, there is a meaningful risk that China will not move at all just to prove a point.   Conversely, there is a decent chance that China will move if the US gives China a few more months.


Domestic conditions in China call for an appreciation.   And the whole point of having a basket peg is to have the flexibility not follow the dollar down.


China’s recent decision to hold the RMB stubbornly above 8 while other currencies depreciate seems aimed squarely at the Treasury, not at the markets.    Tis a funny way to communicate.   But it is still a way to communicate.


Finally, there is value – as former Treasury Secretary Robert Rubin liked to emphasize – in keeping your options open.   Once the US names China as a manipulator, it closes down options.  And it probably overshadows the IMF’s new multilateral surveillance process.   It seems a bit too early to do that. 


On a related topic, I – and lots of others -- spoke with Frederick Kempe of the Wall Street Journal about the political as well as the economic consequences of the extremely rapid growth in the reserves of a host of emerging economies. 


I find it deeply ironic that W’s policies have left the US so dependent on financing from a host of countries that are not exactly friends of freedom.   Countries with different economic systems than the US.   The Chinese, Russian and Saudi states owns a lot more industrial assets than the US state.   And countries with different political systems than the US. 


That strikes me as a big difference between the Bretton Woods system of the 50s and 60s – which knit together a group of allies – and the new Bretton Woods system.


Some of the scare stories that can be generated by growing US indebtedness to some of its geopolitical rivals strike me as potentially plausible, some less so.  I recognize that the countries now financing the US cannot easily exit from the system, at least not without incurring some real cost. Particularly China.  Of course, remainign in the system and continued to finance the US has costs to.  The Saudis presumably could get out a bit easier.  I don’t think the Saudis need to peg to the dollar to be able to find someone to buy their oil … 


But what Larry Summers calls the balance of financial terror certainly adds a new layer of complexity to international political relations.   There is always a chance of financial retaliation – or perhaps attempted financial retaliation -- should the US adopt policies one of its creditors really dislikes. 


Some believe that the financial interdependence between the US and China creates economic ties that will help ease political tensions.  The same presumably now holds for the US and Russia as well.  I am not so sure.  The interest of debtors and creditors are not always aligned.  Remember US relations with Russia back in 1998.


Vice Minister Li’s comments about “rumors” the US wants a 25% devaluation of the dollar (and of China’s savings) may be a sign of things to come.  China probably holds $600b in US debt by now, over 25% of China’s GDP. China has a lot of (financial) eggs in one basket.   And the US has not made any commitment to adopt policies that protect the value of those eggs, so to speak.  


Just as the United States concerns about the implications of China’s peg for its manufacturing sector are a potential source of instability, so too are China’s concerns about the United States' commitment to protecting the value of China’s savings.  


But these are topics I hope to discuss in depth at another time.

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