At his confirmation hearing in January, Tim Geithner nailed the China Question. China prevents its exchange rate from appreciating through intervention (buying foreign currency), and this allows it to sustain a large current account surplus. Geithner said, as plainly as you can expect from a senior official: this is not in accordance with international rules and should stop.
Not only is this sensible economics and correct on the rules, it is also good politics. If you want to head off the considerable inclination towards protectionism in Congress, it would help greatly for the Chinese renminbi to rise in value (e.g., review the discussion at this House hearing).
But almost as soon as Geithner spoke on this issue, there was slippage. By late February, Hillary Clinton was asking the Chinese nicely to continue holding US Treasury securities and, it now seems, punting the exchange rate issue. Above all else, China wants to be left alone on the renminbi – variously arguing that any appreciation would jeopardize jobs, derail growth, and plunge the country into chaos.
So what should we expect from Geithner’s upcoming China trip?
China refuses to talk politely about its exchange rate and rebuffs all sensible diplomatic initiatives on this front – they have held the IMF at bay for nearly 2 years on this exact issue. The rhetoric is that their fiscal stimulus will bring down their current account surplus without need for significant exchange rate appreciation. This is smokescreen.
The reality is that the administration is afraid that China will shift out of its dollar holdings, pushing up interest rates on Treasury debt and jeopardizing their Fiscal First reflation strategy. The Chinese have played up these fears by speaking obliquely on the desirability of a non-dollar international reserve currency – this is a pipedream, but you get the point.
The administration has essentially blinked in the face of Chinese growling. This is strange for two reasons.
First, where would China move its reserve holdings? The other reserve currencies are generally considered to be the pound, the yen, and of course the euro. Which one would you definitely prefer to the dollar these days?
Second, any shift in the Chinese portfolio would also tend to depreciate the dollar – depending on what else is going on at that time – and this would likely push up inflation. However, the administration might welcome some inflation right around now, reducing real debt burdens, and helping banks’ balance sheets and their operating profits. And a depreciated dollar would raise exports, greatly facilitating our economic recovery. It would be awkward for this to be explicit US policy, but any Chinese move would provide the administration with plausible deniability.
The standard view among the very people now running US macroeconomic policy is that the large Chinese current account surplus during the boom – and the consequent build-up of foreign exchange reserves – was destabilizing, because it helped make credit conditions looser in the US. In fact, “don’t blame us, it was the global [Chinese, Japanese, oil producers’] savings glut” is almost a mantra among our policy elite.
Personally, I would not overweight this element of the global credit mania – the financial services metabubble started long before China’s surplus became significant. But I’m seriously worried about the potential protectionist backlash today, given that China is the only major country that does not play by standard international trade and finance rules. The administration thinks it can safely postpone discussing China’s exchange rate for another, sunnier day. I’m not so sure.
Still, not wanting to discuss difficult topics should make for an easy visit to China.
By Simon Johnson