Chinese Dissonance

The G20 needs a deal. It doesn’t make much sense to pull 20+ global leaders together on April 2nd unless you can announce an agreement with some bearing on the current worldwide slump. One more meaningless communique might not go down well with the markets. You can always trot out the same platitudes, but the world’s best journalists will be in attendance and it would be much better to have something concrete on display.

Time is running out for the deal makers. There appear to be no grounds for the US and Europe coming together in a meaningful way on fiscal policy: the US want everyone to commit to some (universal?) target; the Europeans either really don’t want that (Germany) or rightly feel they can’t afford it (most of the rest of the EU). Regulatory agendas intersect but only at the general level of, “we should do better” and ” it was your banks that got us here” – the AIG counterparties list make it clear that already-regulated large institutions in both the US and Europe are the problem. And the US Administration is waiting for Congress on regulation – this will take 6 months or more to sort out.

All of which leaves one main item around which there can be convergence: the IMF. And for this, China’s exchange rate is the issue.

The US has taken the initiative with Secretary Geithner’s proposal that IMF resources be increased by $500bn (i.e., from $250bn to $750bn) through a large loan from member countries.  A loan of this scale has the advantage of providing sufficient support for the Fund over the next 12 months (unless the eurozone takes a major nosedive), while it doesn’t require the long drawn-out negotiation needed to change the Fund’s underlying quotas – the equity/voting structure of the organization is contentious because emerging markets demand more voice, while smaller European countries strongly resist reductions in their (overrepresented) voices.

Last weekend the Europeans rebuffed the Americans on the scale of this loan – preferring to stick with the IMF’s idea of “just” doubling its resources, i.e., an increase of $250bn. Of this, the Japanese already offered $100bn (in fact, this loan to the Fund is already in place).  But in communique pledge math you can count contributions multiple times – come up with another $150bn from around the world and you can claim the $250bn headline.

In principle, this should not be difficult.  In a world of trillion dollar problems, providing some tens of billions of dollars to prevent chaotic domino effects in emerging markets seems like a reasonable investment.  And – here’s a key point – you are only providing the IMF with a line of credit, typically from your central bank, so the budgetary cost is basically zero and the opportunity cost is (a) minimal if you are holding a large amount of foreign exchange reserves, (b) definitely zero if you are a reserve currency country, so your loan is in your own money (which you get to issue.)

So why not just put the US down for $40bn, the EU for $40bn, and China for $40bn – presuming you can put the Saudis down for $30bn?  Not so fast says Capitol Hill – the Administration needs to request an authorization, and this requires a serious conversation.  Still, that’s not too difficult in the current context, particularly if the world is waiting for a formal US answer after the summit and the current level of world trade hangs by a pretty thin thread.

Not so fast or not at all is also the gut reaction of the Germans, who like to think of the IMF as being even more austere than themselves.  Of course, their attitude of “responsibility” looks increasingly irresponsible – what was the point of pushing hard for massive cuts in scarce experienced IMF staff right during the worst economic collapse in living memory?  At this point, other Europeans can probably bring the Germans along, particularly as East-Central Europe stumbles towards further devaluations (tending, other things equal, to move jobs eastwards) and as Europeans all realize – stunning though this may seem – that the only idea they have for weak eurozone countries is to send them to the IMF for loans.

But can you get $40bn from China?  Yes, if you are willing to do a deal.  What do the Chinese want?  Some commitment to further “reform” at the IMF (code for: more votes for China).  The US can do this – because they will keep their veto at the IMF, which is all they really want.  The small (in every sense) Europeans may choke on this, but they increasingly feel the need for China’s commitment to the Fund.  So, the Chinese suggest, if you can’t promise immediate change at the Fund, here is another proposal: stop talking about China’s exchange rate.

China’s exchange rate has, since 2003, been substantially undervalued and China has – unambiguously – intervened to keep it that way.  This has contributed to a massive current account surplus (over 10% of GDP) and a capital outflow (hence China’s currently reserve level of around $2trn) that has contravened the spirit of what large countries are supposed to do and – since a rules change at the IMF in summer 2007 – the letter of its international agreements.  The IMF has, for moderately inexplicable reasons, not yet been able to call China to account; this increasingly grates on Congress, as it should.

So now China proposes: hush money.  Take complaints about the renminbi off the table, and you can have a big loan.  And shut up already about how global imbalances (code for: China’s surplus) contributed to the easy funding environment that fed the latter phases of the global debt boom.  It’s awkward, given the frequency with which policymakers like to blame the “global savings glut” (code for: China’s high savings/current account surplus, mostly), but this is mostly about deleting a paragraph or two from standard speeches.

Is it worth it?  Would this lead to more or less pressure for protectionism in the US and Europe?  If China devalues further, to take the edge off its recession, would that also be OK? 

They’ll work hard to do this deal, or some version of it, in the run up to April 2nd.  Whether it turns out to be a good idea remains to be seen.

33 thoughts on “Chinese Dissonance

  1. Simon,
    I fail to see how bashing helps the explanation and the context. Every country has its own internal problems to fix and respond to in addition to international concerns.

    Another way to view this is that the Chinese beat us at our own game, and the so-called American multi-national companies will still be looking to enforce WTO rules and advantage, not just the IMF. Who runs the show now?

  2. “global imbalances” is code for housing bubbles
    “global savings glut” is code for irresponsible Fed policy

  3. Prof, Johnson,

    I understnd how governments prop up a currency by using reserves to buy it. Could you explain how China props down the renmimbi?

  4. if chinese officials may be concerned about the potential for an imf infusion to strengthen EUR (devalue USD):

    “…A massive IMF infusion would be “as much a bail-out for the likes of Austrian, Italian, German, Swiss and Swedish banks as it would be for Eastern Europe,” he notes…”

    “…the Financial Times reported that Beijing had lost tens of billions of dollars of its reserves having begun investing in global equities, just before world markets collapsed last year…”

  5. “Propping down” a currency is ever so easy – much easier than propping it up.

    Propping up a currency means you need to convince your trading partners to accept your currency at a high value – even though you continue to demand more of their goods (and more of their currency to buy their goods) than your partner demands of your goods (and hence your currency).

    The primary way to do this is to “borrow” their currency, by issuing promises to repay it back in teh future. Presumably, you are “investing” it in productive applications.

    Propping “down” a currency only requires that you convince your own economy (your people) to accept less of a trading partner’s currency – and you keep the difference. You can do this buy just holding onto big wads of foreign currency (to keep it “scarce”). Or by loaning money to a foreign government. Or both (as China has done).

    It’s very much like a combination universal import tariff/export subsidy.

  6. First, China _should_ get more status at the IMF. The fact that it has less power in so many international institutions is absurd. We are in the process of witnessing the decline of US hegemony. The decline of a hegemon often – but not always – is achieved by war. Recent history (transition of global power from UK to US, fall of USSR) suggests that peaceful transition is possible, but not guaranteed (witness German attempts to replace UK as Hegemon in WWI and WWII).

    China has shown the ability, when it wants, to be a responsible global player. (And, frankly, it’s not like the US has much room to criticize at this juncture.) China has certainly signalled its desire to be part of the club, but has also signalled that it does not accept all of the club’s ideas (particularly about individual liberty, human rights, and free trade). The US is going to have to suck up some changes and swallow a bit of pride.

    However, the US needs to assert the right to defend its own economy against unfair trade practices. Period. If the US abdicates this right in exchange for a paltry $40 billion, it will perpetuate this crisis. Nor does the US lack the ability to do this unilaterally – remember, unlike Latin American which borrowed in foreign currency, US debt is in dollars. Should China feel as if it wants to continue its currency policies unchanged, dollar-denominated debt can always be repaid by making more dollars (and using them to subsidize US industries that are harmed by the trade practices – which is perfectly legal under WTO rules if the US can argue that currency manipulation is an unfair trade practice). Friedmanomic theory would eschew this approach; hopefully Congress does not.

    China does not want this – and is waging a public relations campaign to imply this is dishonest. To a degree, they are right, except that the current financial crisis creates many reasons to print more dollars. Moreover, having engaged in mercantilist policies for so long, China has materially contributed to this situation.

    Call it bad international underwriting practices.

  7. Perhaps you could explore how using the US using the IMF is a backdoor way to lock people in even more so to the dollar standard…

  8. By convoking the G20, the US, leading the G7, has stipulated that global financial systems are larger that just the US, Europe, and Japan. Yet if you consider the current makeup of Treasury’s primary dealer counter-parties, you will observe they are all institutions based in the US, Europe, and Japan. Treasury should be encouraging non-G7 financial institutions to join the primary dealer system.

    Of course, that is a privilege that comes with responsibilities, and not all institutions/countries can handle it; for those that can, it would be a feather in their collective cap. It is also a subtle, non-cash GIFT that the US has to proffer in the run-up to the convocation. One would hope the US government is alive to the opportunity here, to engage (or ensnare, if you prefer) non-G7 institutions in the global system as typified by the Treasury primary dealer system – especially considering the large increase in face value that Treasury is going to be bringing to market in the near future.

    (that said, subtle diplomacy, of both financial and national interest varieties, are indicated; and my brief in that regard is actively negative, imho.)

  9. Chinese hush money for a pegged yuan? Argh, that is annoying. If our elites go for this, it is just another instance of elites shafting working Americans to protect their precious outsourcing, offshoring, ‘globalization’. They will be sorry. It’s likely we will exit this year with an unemployment rate in the teens.

  10. One of the more significant documents the government has produced recently:

    (Fed statement)

    The Fed, apparently, is not accepting hush money.

    The $300 billion figure over 6 months is interesting. Interestingly, it’s about half of the cost of the stimulus bill (over 2 years). And only a fraction of the 1 year deficit (1.7 trillion, anticipated). It’s still substantial, but the message is probably more important than the substance – particularly going into the G20 in April.

    I’m glad my prediction for the Fed meeting was wrong.

  11. this blog’s ‘us’ and ‘them’ meme swings between domestic and international dissonance. it seems much is still wagered on the capacity of ‘u.s. hegemony’ (your definition here) to be the first to resolve, strengthened by a process which risks imploding other economies first

    “…Prof. Huang says that, as late as 2002, nearly 40 per cent of enterprises in the city were still owned by the state, a much higher level than in surrounding provinces… he contends, Shanghai is not really creating anything: Its wealth comes from foreign investors and government largesse… “The investments that went to Shanghai to build… big buildings are financed by huge tax burdens on rural areas…” That is a problem because the countryside is home to what Prof. Huang calls “the most dynamic, risk-taking and talented entrepreneurs in China.” Prof. Huang… gives Beijing credit for the tremendous progress the country has made and the many market reforms it has introduced. He concedes that the government is trying to correct some of the distortions it has created… [but] Because of its unsustainable model… “China is highly vulnerable to shocks.”…”

  12. Mr Johnson,

    You sound like Europe, the US, China and maybe Saudi Arabia could reach an agreement and the others would simply follow. Dont underestimate Brazil, Russia, South Africa, India, Mexico and others in that discussion. Reforming global economic governance is an issue you simply ignore.

  13. Not so sure about the exchange rate argument…about 2 years ago, the Petersen Institute (Nicholas Lardy and others as I recall) argued that the RMB needed to appreciate by 20%-25% to better reflect its value. Since then the RMB has appreciated by about 25% (more on a trade weighted basis apparently) and the trade surplus still increased. When wage rates in a developing country are 10% to 20% of a developed country, surely it is not just the fx rate that creates the surplus? China has invested massively in infrastructure, facilities and education and is still a relatively poor country, all factors, when combined, that create massive competitive advantages.

  14. Perhaps the real question should be “how does the world deal with a poor country that is among the most competitive globally?” Have developed countries ever had to compete with a developing country the size and scale of China, with such low per capita income levels, but world class infrastructure, hardworking and thrifty people, and a national focus on economic development? How do you compete with such apparent competitive advantages (ignoring for the moment the environmental and health impacts, the need to increase domestic demand etc). Over 60% of China’s exports flow from foreign invested companies in China….will the US tell their companies to be less efficient? The % of overall exports from Asia to the US have not increased much in the last decade, they now just mostly happen to flow through China as part of the global supply chain so will reducing exports from China change much? China will soon (5 to 10 years?) be joined by India in having a very competitive economy broadly….how will that impact the US and the EU….seems like we are headed for some very difficult times which are being exacerbated by the financial crisis.

  15. Those competitive advantages should be reflected in an improvement in the living standards of Chinese citizens; this is part of building a stable domestic market. If the currency were allowed to float freely, what do you think it would stabilize at?

  16. There is a view at the moment that it would actually decline in value given there appears to be an outflow of money as companies and investors repatriate funds so it is hard to say. There is also wide disagreement on how to determine the “fair value” of a currency. I certainly agree that an appreciating currency will improve living standards which is desirable and needed for the people in China.

  17. The intent of the comment was not to spark nationalist sentiment, but to observe that (urban/rural divide aside) China has sustained annual growth of ~9% for the last decade. At 7% of the world economy (and growing while others are shrinking), its economic influence is on the rise, yet it continues to be excluded from world forums like the G7.

    Dominant nations can either contest or accommodate. Accommodation, however, does not necessarily mean capitulation or appeasement.

    As to the US “imploding” other economies through currency devaluation, this is quite opposite of the truth. Devaluation of a reserve currency frees other nations to engage in more aggressive monetary policy without fear of being caught in a debt/deflation trap (as was Latin American when the US hiked interest rates in the early 80s while Agentina et. al. continued to inflate).

    China’s conundrum is that it has sunk so much fixed industrial capacity in supporting US-targeted exports; that fixed capacity is now idle and losing money. It was clearly not a robust model. China should have, and still needs to, dedicate more resources to its internal markets. Part of doing that is giving its citizens more purchasing power, and that means allowing the Yuan to appreciate.
    This is relatively easy to fix…

    The EU has its head on backwards. Perhaps the Germans want the Euro to be the world’s reserve currency (what a prize that is!). They seem intent to bankrupt their neighbors for that privilege. The devaluation of the dollar will hopefully force them to do what they should have been doing all along – print Euros and use the cash to reflate European economies. The Germans are destroying their own trading partners and thus its own export-dependent economy; it’s gotten to the point that the primary corporatist organization – the BDI (business federation) – is pressing the ECB for some sort of monetary easing.

  18. thanks to both Peter and StatsGuy – but no one seems to be addressing ‘globalization’ in the sense of cross border flows of financial, intellectual and human capital, tightening market co-relations, global infrastructure development and migration among the nations you mention – surely chinese investors have interests in protecting and enhancing their investments in europe, north and latin america and africa as much as anyone else does.

    and russia still needs to build its’ pipelines:

    “…Russia is mostly a pipeline exporter, and the elasticity of pipeline exports is not as high as that of, say, automobiles… Russia is the only country among the Group of 20 with double-digit inflation… Russia’s key dilemma is how to contain inflation while allowing the Central Bank to cut its benchmark interest rates. Meanwhile, in an environment of soaring Central Bank lending in recent months, the relatively cheap and abundant supply of rubles was converted into foreign cash, thereby shrinking the money supply. This stands in contrast to what occurred in other countries, where many banks loaded up on toxic assets. This was never a problem in Russia. Given that Russia’s financial system is not as deep as those in other countries – the total ruble money supply fell to around $330 billion as of Feb. 1 – Russia’s version of the balance sheet recession should last for a much shorter period of time.”

  19. Better late than never, I hope; but maybe it is not necessary to ask China to raise the value of the renminbi.

    Currently, Russia, for example, uses its currency reserves to buy roubles and prop them up. (This managed devaluation is working much better than in the 1990s.) Above, I asked how a currency is propped down. Thanks, StatsGuy and BigBadBank, but an interesting article explains how China does this and why it is self correcting, at least in the long run.

    Tabita Kaneene, in Foreign Policy, Feb. 2009, explains how it is done, The government sells renminbi (yuan) denominated (PBOC) bonds. The yuan proceeds are used to buy dollars. This props up the dollar with respect to the yuan (props down the yuan). There are no net yuan in circulation (called “sterilization”) so, theoretically, the money supply isn’t increased and is non-inflationary. The dollars are, in turn, invested in U.S. Treasuries. However, according to Kaneene, because there are so many outstanding, PBOCs are paying 5% vs. 0% for Treasuries and inflation is still 9%. This can’t go on forever and there are other more useful requests to make of China.

    One not mentioned is IMF funding.

  20. “…a true economic union with completely open borders and free flows of finance is simply not consistent with extreme volatility in exchange rates. And the ultimate protection against that volatility within Europe is a common currency. Among the nations of Southeast Asia, where trade with the rest of the world is so widely diversified, there is discussion about the possibility of emulating the European approach by forming a regional currency in an attempt to provide a measure of stability. Success in that effort would be, to put it mildly, surprising. Unlike Europe, intra-regional trade is limited. There is an absence of both a strong national currency and a well developed financial center to anchor the system. East Asia would remain exposed to the wide fluctuations in exchange rates among its major suppliers and export markets. What those events and yearnings do suggest, however, is the strong possibility that over time we will see regional economic areas built around zones of free trade and close currency relationships. That tendency will be encouraged by NAFTA and a wider Western hemisphere free trade zone. In larger Asia, in the decades ahead, it could be the Chinese yuan rather than Japanese yen that emerges as the regional anchor…” Paul A Volcker, 04.03.01

  21. Not to be nitpicky, but…

    To claim that demand for PBOC bonds is low because their interest rate is 5.3% vs. near 0% for US short term rates ignores the Chinese inflation rate (mentioned in the same article) which is well above 5.3%. In other words, the real yield on PBOCs is negative, suggesting demand is not that “low”.

    Second, the article repeats many free-trade truisms that ignore long term trends/impacts:

    — “by keeping imports cheap, it increases the purchasing power of the average U.S. consumer”

    — “which helps keep U.S. interest rates low, allowing firms to make investments that would be unattractive at a higher cost of borrowing”

    and, of course:

    — “Chairman Alan Greenspan testified in 2005: “I am aware of no credible evidence that … a marked increase in the exchange value of the Chinese [yuan] relative to the dollar would significantly increase manufacturing activity and jobs in the United States.””

    In other words, the US should be grateful because Chinese suppression of the value of Yuan has been so good to the US economy and consumer.

    The problem is simply that US consumers have a “taste for consuming instead of saving”. This is the argument now being used by Chinese monetary authorities.

    Which begs the question – if the gluttonous US has a problem with consuming too much, why is China going to such lengths to prop up that consumption?

    And these other questions:

    Should we really be grateful for China helping keep US interest rates low, when it has become clear that recent bubbles are largely a function of excessively low interest rates even as consumption rises (which should not happen in a closed loop economy)?

    If economists now blame Greenspan for holding interest rates too low in the early part of the decade, then why are they not applying the same logic to Chinese trade subsidies?

    And, even better, when firms borrowed money cheaply, did they _really_ make good investments that are now paying off, or did they just frivolously waste it?

    In a classic macro comparative statics model, it’s easy to show that Chinese currency manipulation helped the US. Not unlike free trade advocates arguing that its non-optimal to impose penalties for foreign subsidies.

    If you broaden this to include other domains of econ, say industrial organization and labor economics, the picture is a lot murkier – in particular, there are issues such as knowledge transfer, learning-by-doing effects, fixed capital assets, natural monopolies, local externalities, etc.

    As to Greenspan’s statement, he’s aware of no “credible” reports linking US job loss to China trade. I wonder what Greenspan’s standard for “credibility” is?

    I don’t suppose reports like this are credible?

  22. It may well be true that China’s currency is undervalued, but I’m worried that history will repeat itself a la the Hawley-Smoot tarrif tit-for-tat during the Great Depression. Actually, it may well be that human nature, and history, really does tend to repeat itself, so maybe we should all keep a serious eye on ANYTHING that might take us back to the days of Hawley-Smoot. That is to say, any pointing the finger at one country or another. What I’m trying to say is, this is not the time to focus on the value of China’s currency. The United States won’t get our economy in order through some deux es machina from China. It may take bold action, like even more reflation, and some serious new approach to regulating the financial industry, so this doesn’t happen again in the future. The one thing we don’t need to do is to focus on the sins of someone else (in this case, China); we need to focus on how can we act boldly and effectively in our own country.

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