from Global Economy in Crisis

Avoiding a U.S.-China Trade Showdown

Morgan Stanley executive Stephen Roach says China’s undervalued currency is a "red herring" in the debate over global imbalances and that policymakers should instead focus on China’s social safety net and boosting U.S. savings.  

October 21, 2009

To help readers better understand the nuances of foreign policy, CFR staff writers and Consulting Editor Bernard Gwertzman conduct in-depth interviews with a wide range of international experts, as well as newsmakers.

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U.S. Federal Reserve Chairman Ben Bernanke has warned that the global imbalances between the United States and China must be addressed immediately to prevent future economic crises. U.S. policymakers and experts have asserted that an undervalued Chinese yuan is largely to blame for these imbalances and that China’s currency should be revalued to help close the U.S.-China trade gap. Stephen Roach, chairman of the Asia branch of U.S. banking giant Morgan Stanley, says that argument is flawed. He says the undervalued yuan is a political "red herring," since currency adjustment or trade sanctions against China would not help reduce the U.S. deficit but shift the U.S. demand for imports to other more costly exporters. Instead, the United States should be pushing China to create a social safety net that would encourage its population to spend more savings on domestic consumption. Roach expresses concern the United States will enact more protectionist policies against China in response to domestic political pressure over rising U.S. unemployment and slow growth.

In the past you’ve argued that a significant revaluation of China’s currency would prove ineffective in resolving global trade imbalances because of the country’s fractured political and banking systems. Has your view changed?

This whole exchange rate issue is a red-herring. It won’t help the world deal with global imbalances, let alone China. It’s true, in the U.S. we’ve been in a down-trend with the dollar now for seven-and-a-half years and apart from this recent cyclical reduction in our trade deficit, it’s had virtually no impact on the structural savings deficit that the United States has. The same thing is true on the Chinese side of the equation. China needs to stimulate internal private consumption to deal with its piece of the global imbalance equation and the currency adjustment of the renminbi is really a relatively insignificant part of that adjustment process.

To what extent does China have the means to reduce its domestic savings and wean itself off of an export-based economy? If not through the exchange rate, then how?

It’s got a lot of options to pursue. The one that is potentially most significant would be to build out the social safety net in terms of investing significantly in social security, private pensions, medical insurance, [and] unemployment insurance. There are other things that China can do on the private consumption front like boosting rural incomes, and fostering the development of domestic consumer product and service providing industries. But the safety net is the single most important thing that can be done, rather than focus on the currency.

How big are China-based multinational corporations now and how do they factor into this issue of global imbalances?

We don’t have a bilateral trade problem with China. We have a multilateral trade problem with over one-hundred different trading partners.

They’re a big deal. Over 60 percent of export growth over the past twelve years has come from growth by Chinese subsidiaries of Western multinationals, but again the problem I have is that too many in the United States, especially the Congress but also Washington, focus on the bilateral trade imbalance between the United States and China. That’s just a fundamental economic mistake that’s being made. We don’t have a bilateral trade problem with China. We have a multilateral trade problem with over one-hundred different trading partners. Last year, the United States ran bilateral trade deficit with almost one-hundred countries. And the reason for that is that we have a savings problem. And when you have a major savings problem, you have to import surplus savings from abroad in order to grow and you run multilateral trade deficits with a broad cross-section of a number of economies. The Chinese piece is the biggest because of the outsourcing decisions made by U.S. multinationals that you alluded to. But if we were to close down trade with China through some ill-begotten trade legislation or currency adjustment, we don’t save the deficit. It just goes somewhere else. And they usually go to a higher-cost producer, which taxes the American public.

Do you expect the United States to take more protectionist measures with China in the future, and if so, how will that affect global imbalances?

I hope not, but I wouldn’t rule it out. There’s a risk in 2010 that narrow-minded U.S. politicians could contemplate once again bipartisan trade sanctions imposed on China. The unemployment rate is extremely high. The discontent from the American work force is extremely high. The inclination for politically inspired China bashing is extremely high, and so [although] trade sanctions against China are wrong [and] not well thought out, there’s at least a 30 to 40 percent change they could happen.

Analysts worry that ballooning U.S. debt levels could lead to a devalued U.S. dollar, inflation, and stifled economic growth. Meanwhile, China is worried about its U.S. debt holdings losing value over time. Which country has more to lose from the U.S. debt problem?

It’s a much greater risk for China than it is for the United States. The United States is dependent on Chinese exports because we’re living beyond our means. We don’t save. And when you don’t save, you need savings from abroad to close the gap, and you have to run massive current account and trade deficits to [do] that, which means you become reliant on goods made outside the United States. This is the choice that we’ve made. If we want to redirect our economy away from excess consumption towards more of a savings-based economy, then and only then, can we wean ourselves off of Chinese products.  China certainly has gotten the message loud and clear that the external demand underpinnings of the old export-led model aren’t going to work the way they used to and that’s a critical outgrowth of what’s likely to be a multiyear shock to consumer demand growth in the United States. So China knows what’s going to happen. The question is do they believe it and are they now formulating strategy on the basis of that possibility. The United States right now is probably operating under the misguided assumption that China’s going to be there to just buy Treasury debt for years to come. And the odds are that that will probably not occur, at least [not] on the financing terms the United States has been able to get for selling its debt to international investors for the last several years.

The biggest reason to worry about a more precipitous decline of the dollar would be if the U.S. Congress were to enact bipartisan trade sanctions against China and President Obama were to let them go through and go into law.

Is China putting policies in place to induce domestic consumption?

No, they’re not. They’re sort of talking the talk, but they’re not walking the walk. When they realize that the U.S. consumer is not going to come back with the vigor the sector has displayed over the last twelve years that will be their wakeup call to do more in the way of heavy-lifting on these pro-consumer policies. I think right now, the policies they put in place have been rather disappointing.

There’s a lot of speculation about the demise of the U.S. dollar and whether another currency could take its place internationally in future. Do you see that happening? If so, when?

Reports of the demise of the dollar are greatly exaggerated. The dollar is under downward pressure. Over the last seven and half years, the average annualized decline has been about 3.5 percent, which is hardly a disaster. Like any secular downtrend, there’s always a crisis scenario that you could worry about. And to me, the biggest reason to worry about a more precipitous decline of the dollar would be if the U.S. Congress were to enact bipartisan trade sanctions against China and President Obama were to let them go through and go into law. That would be much more consistent with a dollar collapse scenario.

Will the dollar be replaced in the long term?

The dollar’s role as the dominant reserve currency is going to remain intact for several more decades. There will come a time, hopefully gradually, where the world is more advanced down the road of globalization, [when] economic power is spread more evenly around, not just in the supply side of the world but in the demand side of the world. At that point, it would appropriate to think more about a multi-currency reserve system. It could be along the lines of the IMF’s Special Drawing Right, but this is going to take I’d say fifteen to twenty years at a minimum.

Do you see Chinese government shifting toward greater support of entrepreneurship or state-run industry?

No, they’re moving much more toward privatization [or], as we say in China, the corporatization of state-owned enterprises. From time to time, there’s an ebb and flow in terms of their commitment, but I don’t buy the notion that because of a big surge in bank lending you have to call China a more statist economy today than it was going into the crisis. They’ve been pretty much a government-directed policy machine since the inception of the People’s Republic of China sixty years ago. They’ve backed away from some of that, but you know, there’s still an important legacy of public sector involvement and control. It’s been shifting [toward liberalization] for the last fifteen years under the guise of state and enterprise reform. It’ll continue to shift in the years ahead, but the shifts are uneven. There are periodic setbacks because of the business cycle, such as what we’re seeing right now. But I think the direction is set.