Obama In China: Breaking The Exchange Rate Deadlock

President Obama leaves next week for a high profile trip that includes meetings with other “Asia-Pacific” countries (in the APEC forum) and a visit to China.  The President has had considerable diplomatic success on the economic front to date, including at the G20 summit in April and – to a lesser degree – at the follow-up September summit in Pittsburgh.

But the issues facing him now in Asia are particularly difficult, primarily because of China’s exchange rate policy.  China essentially pegs its currency (known as the yuan or renminbi) against the US dollar, which means that it rises and – most recently – falls in tandem with the greenback.

Many countries operate de facto pegs of this nature, but China is problematic for three reasons: it is a large economy (10 percent of world GDP, if we adjust for purchasing power), it runs a big current account surplus (exporting more to the world than it buys from the world, in the range of 6-12 percent of the Chinese economy), and it consistently has a bilateral surplus with the US that is galling to many on both sides of the aisle on Capitol Hill (and their constituents).

The political backlash is not without foundation – jobs have moved and continue to move to China in part because Beijing’s exchange rate policy gives Chinese exporters an unfair trade advantage.  This has long been recognized and China committed as long ago as 2003 to address this issue, but the Bush administration was unable to achieve any lasting success on this front – despite repeated head-to-head talks at the Cabinet Secretary level. 

The Chinese currency remains at least 20 percent undervalued according to the Peterson Institute for International Economics (disclosure: I have a part-time position at the Institute but don’t work on this calculation); quietly, US officials do not disagree with such numbers.  As a result, China continues to accumulate foreign exchange reserves at a dramatic rate – it reached $2 trillion earlier this year and will like have $3 trillion around the middle of 2010 (i.e., equivalent to 20 percent of US GDP; a huge number).

The Bush administration, quite reasonably, tried to give the job of handling China’s exchange rate to the International Monetary Fund – beefing up its long-established mandate in this area.  Unfortunately, the IMF has proved unable to make any significant progress, largely because it lacks the legitimacy necessary to wield any kind of stick on the issue.  The Chinese just continue to say “no”, politely, and the IMF has backed down.   

This is embarrassing for Mr. Obama, particularly as his strategy at the G20 has been to play up the importance of “global imbalances,” which implies that over the next 12 months, the focus will be on reducing both the Chinese current account surplus and the US current account deficit.

What should he say both to China and to its neighbors – who also increasingly find China’s exchange rate policy worrying, particularly as the dollar faces pressure to decline?  Mr. Obama needs to find a carrot and at least the shadow of a stick, but he really does not want to go anywhere near a trade war (remember the tit-for-tat protectionism of the Great Depression).

A compelling argument is actually hiding in plain sight.  As a result of easy monetary policy in the United States, combined with the rapid rebound of the Chinese economy, China now faces record capital inflows.  These inflows are greatly encouraged by the inevitable prospect (in the minds of investors) that the renminbi will rise in value against the dollar within the foreseeable future.  If you have access to cheap financing and implicit US government guarantees, for example as does Goldman Sachs, borrowing in dollars and investing (e.g., through private equity deals) in renminbi looks like a one-way bet.

The longer China resists appreciation and the more it protests that no one should interfere with this aspect of their sovereignty, the more the capital will pour in.  This can have beneficial aspects, in any country that is trying to grow fast, but it can also be profoundly destabilizing – Mr. Obama should talk gently about the experience of Japan in the 1980s, the US this decade, and almost all emerging markets pretty much every decade.

Talking in public about big sticks never goes down well in Asia, and the administration should deny any inclination in this direction.  But the mainstream consensus is starting to shift towards the idea that the World Trade Organization (WTO), not the IMF, should have jurisdiction over exchange rates.  The WTO has much more legitimacy – primarily because smaller and poorer countries can bring and win cases against the US and Western Europe in that forum.  It also has agreed upon and proven tools for dealing with violations of acceptable trade practices – tailored trade sanctions are permitted.

No one wants to take precipitate action in this direction, but extending the WTO’s mandate in the direction of exchange rates would take time – and presumably warrant discussion at the G20 level.  The US has great influence over the G20 agenda and Mr. Obama’s staff should hint, ever so gently, that this is where they see the process going.

By Simon Johnson

An edited version of this post previously appeared on the NYT’s Economix blog; it is used here with permission.  If you would like to reproduce the entire post, please contact the New York Times.

74 thoughts on “Obama In China: Breaking The Exchange Rate Deadlock

  1. Do not think of it as a currency peg; think of it as a Sino-American currency union.

    My question is, what are Chinese policymakers thinking, exactly? Do they believe they can accumulate dollar reserves forever, with no upper limit? Do they see no risks to themselves at all from such accumulation?

  2. Oh I can hear the Chinese school-kids laughing him off the stage like they laughed Turbo-Timmy I signed a note to pay taxes on this and didn’t Geithner.

    Any third grader with a pocket calculator knows we are insolvent. We owe north of 80 trillion and we earn less than 8 (GDP is cooked, own a house the BEA adds what you would pay but don’t in rent to GDP).

    We will, without a doubt, wake up in a massive war or we will become a Zimbabwe banana republic. Money is the issue.

    Good read by the way, thanks for all you do, and I see they didn’t invite you to the blogger Treasury meet up?

  3. Unfortunately, China isn’t Japan. It is a huge, populous, undeveloped, resource rich country lacking only advanced technology which it continues to acquire by accepting dollars in exchange for manufactured drek. China isn’t a capitalist country. Its central bank can sterilize the dollar holdings and deal with internal speulation in the old fashioned way: executing speculators. China has no incentive to change its developmental game and our lunatic monetary and fiscal policy increase its leverage hour by hour. As for the President, his talent is bamboozling voters and they don’t vote in China. Too bad he is’t sending Rubin and Summers and Greenspan. They might succeed by creating confusion. It worked here for fifteen years.

  4. This is a pretty funny measure of bamboozling voters.


    According to them Obama has an excellent record of keeping his campaign promises.

    That is, until you look at the puling little list of trivia they call kept promises.

    Not exactly the stuff of world-historical Change You Can Believe In.

    As for Chimerica, it seems like they/it are in that special place where you want to get there but can’t get there from here.

    How is China supposed to decouple and build that monster consumer economy the world awaits breathlessly? How can you turn a billion peasants into Western style consumers? How do you create service and IT jobs for all of them? And what about $1.5 trillion in dubious dollars you have stashed in the mattress? What on earth are you supposed to do with that?

    It’s the headaches they get asking themselves questions like these which tires them out to the point that they just keep the currency peg and undergo the propaganda exercise of a makework stimulus whose activities only reinforce the existing export infrastructure and blow up asset bubbles. They’re literally tearing down perfectly good bridges in order to rebuild them.

    Not a solution.

    And judging by his “innovative” domestic policies – cash for clunkers, housebuyer tax credits, and other transformational, not-at-all-reactionary breakthroughs – I don’t think Obama looks like the idea man who’s gonna help them/us find a way out.

  5. Please don’t forget Health Care and Cap and Trade and cash for dishwashers and God knows what else.

    This guy is hell bent on destroying the dollar.

  6. Obama’s trip to win the olympics for Chicago, his five visits to NJ to get Corzine re-elected and now a trip to China to convince China not to peg, manipulate their currency as the US manipulate’s, devalue’s their currency. Good luck with that Obama.

  7. The reality is that China has been fighting a trade war against us for decades, and they have been winning. Their primary weapon has been pegging their currency to the dollar. That is why they have all these billions to invest and it has done massive damage to the US economy. We should do everything we can to decouple the yuan from the dollar.

    The article says that the yuan is at least 20 percent undervalued. I believe that is very low given that the dollar is, and has been for decades, extremely overvalued if you only include free market factors. The dollar’s value is inflated by several factors. They say that it is the World’s reserve currenct, bu that is just another way of saying it is propped up by other central banks to help their economies at our expense. It is seen as a safe haven which also inflates its value. And using the dollar as the medium of exchange for oil and other commodities also keeps it high.

    The US economy cannot and will not have a real sustained recovery without rebuilding our manufacturing sector, and that won’t happen as long as the dollar is so artificially strong.

  8. Prior to 2009, China’s strategy appears to have been to slowly crawl the peg, and permit a high inflation rate (8% per year) until the valuations of the currency were rebalanced.

    However, the crisis sort of messed that up. Note China’s monthly inflation rate:


    They’ve also ceased their crawling peg adjustments.

    It’s possible that China is still trying to “inflate” its way to parity, something that would take (if they could achieve 8% inflation) about 3-4 years to complete (2013). But 2013 is a long way off, and a long time for the world to endure these imbalances.

  9. I grow increasingly tired of addressing these misunderstandings, but here it goes again:

    Our “lunatic” monetary policy certainly has the effect of devaluing the dollar – which is _precisely_ what is supposed to happen when we have a trade deficit. You can argue about why the dollar _needs_ to fall (and I believe the overwhelming reason is excess federal debt incurred by Reagan’s fiscal policies, and then Bush II’s “borrow and spend” policies), but keeping the dollar artificially propped up (a la Reagan) can only worsen the problem in the long turn. (With regard to arguments about commodity import inflation, please read about the J curve before responding to this comment.)

    Also, our “lunatic” monetary policy (e.g. devaluing the dollar) gives China GREATER incentive to change. This is patently obvious if you think it through: China is holding a vast dollar reserve. By signalling that we will devalue the dollar, China has fewer incentives to try to earn more dollars and greater incentives to try to spend its existing dollars.

    Fiscal policy has precisely the reverse effect (leaving aside the impact on expected default probability).

    Also, China is not in a great situation either – they have an export sector with fixed assets dedicated to manufacturing exports for a defunt economy, they own a defunct economy’s currency in abundance, and they still have a hugely inefficient public sector (with a private sector that is primarily in the export focused areas), and an underdeveloped internal market. They are, frankly, scared to devalue.

  10. No need to worry about the RMB:USD peg. They’ve got Uncle Ben’s monetary policy and unabating fiscal policy backed by $2t in FX reserves. China’s REER implies a steady, persistent decrease in competitiveness for their export sector.

  11. “China essentially pegs its currency (known as the yuan or renminbi) against the US dollar, which means that it rises and – most recently – falls in tandem with the greenback.”

    Ok, but let’s not forget that the RMB has appreciated some 17% against the dollar since 2005. That is a bit more than a “crawling” adjustment, but StatsGuy is right to note that the economic crisis put all of this on hold.

    We have to stop thinking about the US as a victim in this trade relationship. China doesn’t really want to have all of these dollar assets either. For the US to complain is like mortgaging the farm and then bitching that the bank is charging too little interest. Would the US prefer if China stopped buying debt?

    The solution lies in fiscal responsibility, and China has been trying to get that message through for the last year. Mr. Obama should not talk about the exchange rate at all. He should talk about market access for US companies in China and bringing investment from China into the US.

  12. Over twenty years ago, I read some on racism among oriental cultures. Racism not only between each other but the world as a whole. IIRC, the oriental’s see themselves as the dominant race followed by the white europeans, then the brown latino’s and the bottom were the black Africans.

  13. What China has been doing is more than fighting a trade war with us, this is really just an extension of the cold war. Whereas the Soviet Union adopted a strategy of pacing us on armaments spending until they went broke, China adopted a strategy of undermining our economy by offering cheap trade goods that our home grown manufacturers could not compete with. The result has been a great loss of manufacturing jobs in this country and larger share in our GDP of the financial/banking/debt servicing sector. U. S. government policy has been to encourage this new sector that reaped huge profits with reduced overhead (i.e. – fewer workers.) They did this by deregulation and an official policy of looking the other way to the business practices of the players in the field. As this debt sector grew and reached a natural saturation point, some way had to be found to keep the sector viable and that was to sell off part of the debt overseas, much of it to China (I’m not sure why anyone in our government thought it was a great idea allow us to become so indebted to a country that has vowed to destroy us.)

    The point is, much as we brought down the Soviet Union by economic measures, China is doing the same to us, letting our greed become our undoing.

  14. Nemo – When Simon says the renminbi will rise in value against the dollar within the foreseeable future, how is that possible if it is pegged to the dollar. Doesn’t the rising tide lift all boats?

  15. What about the USA having an industrial policy and positive interest rates? Those who teach ought to be an example.

  16. They say there are 55 minorities in China, the majority is Han. The question is do we have blood on our hands when we deal/trade with people who treat their own people as subhuman?? There are many crimes which happen on a daily basis in China that we never hear about. Including a black market for children to Chinese parents with fertility problems or who don’t want female children. Also many Uighurs in the Xinjiang region of China have been falsely imprisoned and murdered. Yet we continue to trade with them.

  17. Rebuilding our indusrial sector and having positive interest rates work against each other. Higher interest rates would make the dollar stronger and drive more manufacturing overseas.

    But check out municipal bonds as an alternative to CDs and money market funds. Their interest is tax free and you can get some pretty good rates even now.

  18. “Pragmatist”: what you seem to advocate is the traditional reasoning, expounded by the chorus, including Krugman. There are many reasons to believe this chorus sings the wrong song. The dollar is way too weak already. Other countries are switching to positive interest rates, and the dollar may collapse.

    There is no rebuilding of the industrial sector, at this point. That would be to the US presidency to lead this, but it seems incapable of it. All it hopes for, apparently, is that the mental dwarfs of the financial system will do it. But it’s an engineering problem, nothing that greed can solve.

  19. This Article started out with currency imbalance, has now side-tracked to racism in China.
    I would like to share my observation.

    Well, before a nation gains its independence, the people will drive out any inequality (i.e. arises from the difference in skin color) or foreign threats by staying unified. The common theme is: Unite.

    Once the objective is achieved, the game changes.

    All of us (i.e. same skin color) are equal, then why should one listen to another?
    Why should I submit to you when you are equal to me?
    They disintegrate and differentiate themselves in order to gain supremacy to rule.
    Note: the idea of using “proletariat” and help one very popular guy to rise all the way (politically).

    Racial discrimination sets in (almost naturally) among themselves.

    This happens everywhere.

    Especially, Chinese fighting against Chinese is a very common phenomenon throughout the 5000 years old history of China.

    They are living and sharing resources in one large landmass, but they (mentally) don’t quite see themselves as equal counterparts.

    To the communists (or socialists whatever), brute force is the most reliable means to win over any arguments.

    The Westerners (being a gracious society), thinking that they can get the Chinese to commit by coaxing and using soft tactics, must be dreaming.

    Fight is might. When one wins the fight, then negotiation or talks can ensue.

    (this is my observation. I don’t necessary agree with this form of thinking.)

    Whether China is a racist country or not, this is not the main issue.

    Boycotting or refrain trade with China is suicidal to US. Where else can you find such a large country which is eager to trade or spend ?
    The inter-temporal concerns must be noted too.
    200 Years-old nation (US) v Seemingly Young nation (China).

    A large country (i.e. US) can chalk up such a high level of debt primarily because it believes it won’t be annihilated or suddenly disappear from earth.

    All these high level summits are just empty talks.

  20. The decrease in competitiveness is undoubtedly true, and is indeed largely (but not entirely) driven by the dollar devaluation.

    China sells stuff to the US in exchange for subsidized dollars, then needs to use those same (devalued dollars) to import raw materials to process into exports. This, of necessity, narrows the profit margins and the numbers report this as a decrease in competitiveness.

    If the dollar keeps devaluing and China continues to subsidize it, then there will come a point at which China is paying more for inputs than exports (because it buys imports in devalued dollars). This, of necessity, will force a Yuan revaluation.

    Devaluing the dollar, really, is the best way to force balance back into the system and allow the markets to work properly. (Unless, of course, you wanted to start slapping on punitive tariffs, which create all sorts of political problems because they are so visible and targeted…)

    Keeping a high dollar, by raising interest rates, only enables China to further pursue its mercantilist policies (which will ultimately hurt everyone, including China). Moreover, it would gut the US economy at a very sensitive time. The only benefit would be to reduce commodity import prices, which are being balooned by the carry trade.

    And while I’m no fan of the carry trade (particularly since the US taxpayer is funding it), if the Fed foolishly (as in summer of 08) weighs the price of oil as more significant than the price of carrying our huge debt load, then we are totally hosed.

    It’s also one of the few things that has begun to wean the US economy off of imported oil, since we clearly lack the political will to do it ourselves. (So instead of the government taxing oil imports, instead we have Wall Street taxing oil imports using government provided money…)

    Incompetence and corruption all around… But lest anyone think I’m slamming Team Obama too much, Team Voldemort was vastly worse during its 8 years in office.

  21. I think half the problem lies in the terminology of weak vs. strong. As we are a silly people, too many of us get caught up in this nominclature that somehow a strong dollar equals a strong country equals physically strong population, instead of it simply being an economic statistic. It’s like a 14 year old boy not wanting to wear a pink shirt because it would signal homosexuality.

    So forget the terminology, the dollar is at a lower level now than it was before – an artifically high level probably in the first place. This declining level helps out exports, makes up for our low interest rates vis-a-vis other countries when trying to market our debt, and lowers the value of Chinese and Japanese reserves which as Stats Guy has said, should free up those reserves to be inveseted in the global marketplace rather than hoarded. All positive things during this time of economic stagnation. Let’s start talking about smart vs. dumb dollar policies instead of strong vs. weak and let’s get some politicians who understand that a “weak” dollar doesn’t mean you need Viagra.

  22. Ted, this is just another in a long pattern of America’s dealing with despots in the name of capitalism. Capitalist America would rather deal with a ruthless dictator as long as he kept money flowing into their pockets. Look at America’s long history of interfering in other countries politics when so-called socialist governments were elected by the people of that country, governments that threatened American business interests. We’re not involved in Iraq simply to spread democracy around the world. Truthfully, we wouldn’t be there right now if George W. Bush had not had a family grudge against Saddam Hussein and the wealthy Republican clique that ran this country at the time didn’t think they could make money at it. While we have given lip service to the cause of human rights in China, our government is not going to make waves against a country from which our economy has come to depend on so much.

  23. I rather think the Chinese are the ones who get more blood on their hands by trading with the US…


    That’s not to condone China, but it’s every so hard to criticize from a position of weakness. I don’t know that I really understand morality at all.

    We are better focusing our arguments on labor rights/environmental regulation parity, and using regulation-equalizing tariffs at the border to prevent international business from arbitraging production activity across borders and using this to rip down labor/environmental regulation in the US.

    At the very least, this is a policy we can impose unilaterally – except that labor-arbitraging management has no incentive to allow such legislation to move through Congress.

  24. I think the peg will have to be abandoned sooner or later due to the simple reason that it has outlived its usefulness. Countries pegged to the US$ (or another currency) in order to gain credibility for their currency and a monetary anchor in lieu of a sound, home grown, monetary policy. Since China (and others like India) are pegged to the USD, they are importing our monetary policy as well. The inane, inflationist, reckless, bubble blowing policy that the Fed is now pursuing is no longer in their interest. They will break the peg when they realize that the policy has outlived its usefulness and is leading to bubbles in their asset markets. The stabilizer has now become a destabilizing influence.

  25. Yes, the number of people who equate “strong” with “good” and strong currency with a strong country is astounding. The main point should be that the real exchange rate is mis-aligned by government policy, and that such distortions have a mix of positive and negative consequences.

    Changing that fx rate to the “right” level is impossible, because no one knows exactly what it is. But the direction is pretty clear.

    The other argument for doing something is that doing “nothing” is also a choice, and one that implies the real exchange rate will still be pressured to adjust to its equilibrium level by economic forces. If the CNY needs to appreciate in real terms, but the nominal rate is fixed, what does that mean? Well, Chinese inflation (domestic prices, including, importantly, wage levels) must increase faster than the USA’s. This actually will exert deflationary forces on the USA, and also increase the burden of adjustment in the short-term on the Euro and China’s other trade partners. Roubini and Setser explored this dynamic back in 2004-5, I believe.

  26. Isn’t part of the problem that China (by policy) has curtailed the ability of anyone making a significant speculative attack on the currency? My understanding is that the China central bank has currency/capital controls that prevent anyone from buying or selling large quantities of yuan/renminbi, ostensibly so that they can make an offsetting purchase/sale to maintain the peg.
    They “learned” from Thailand et. al. in 1997 too well.
    In this case, it will take an extreme form of “financial innovation” to circumvent the capital controls.

  27. Simon what you argue makes no sense.

    China doesn’t need to open up to flows of capital.
    As you yourself argued in July, capital controls are the new thing.

    If this is the leverage the USA has over China, think again. It won’t work.

    Yes we have leverage, but we will never use it if we are too wimpy to even call China a currency manipulator. We have no stick, by choice.

  28. Patrice

    Without a weak dollar we cannot rebuild our industrial sector. If we cannot rebuild our indutrial sector our economy is doomed to collapse. Then what good would positive interest rates do?

    Also I would like to see how you could justify a stronger dollar. We have had massive trade deficits for decades which would have weakened the dollar if other forces had not propped it up. Those forces include the Chinses pegging the yuan to the dollar, other central banks propping up the dollar for the benefit of their own economies at our expense (they call this using the dollar as the world’s reserve currency) and using the dollar as the medium of exchange for commodities, particularly oil.

    It has been the artificially strong dollar that has destroyed first our industrial base and now our whole economy. It has done this by making imports cheap and our exports expensive in other countries.

  29. Oh and the president cannot rebuild our industrial base. Only markey forces can do that. The artificially strong dollar has put all those market forces out of kilter

  30. You have over 80 trillion in debt and unfunded liabilities. The debt can can’t be kicked down the road any longer, they take in 2 trillion and pee away 4 trillion.

    Forget about a “weak” dollar and rebuilding ANYTHING. The gig is up, we are insolvent. It is re-denominate and start over.

  31. well they do have some of the same issues. they have an aging population (just like Japan). and they also have a shrinking population (just like Japan). but they have a much bigger population to start with so it would be a while before they would see much of a problem with that. they do also share the lack of much local demand for goods

  32. well it would be the second administration to try. and likely to fail too for the same reason. they have no interest in changing at this point. its not in their interest they need the jobs to much to allow it to be different

  33. well as the dollar falls in value, guess what the rest of the world is doing? doing the same? the only things that aren’t falling in value is commodities. but they have been propped up by speculators and nothing else

  34. no. they don’t care about government debt. what they care is about our debt. which is many times the size of the governments debt. with little chance of doing much about it. and that debt bomb has hit them in their exports. as we pay debt down we aren’t buying their stuff

  35. The CNY is not going anywhere until the PBoC allows it to.

    Prof. Johnson did not say it would rise in value within the foreseeable future; he said in the minds of investors it will, which is a different statement.

    If he is right about the capital flows, then what we have here is one entity — the Chinese central bank — with the power to print yuan fighting against other entities — e.g., Goldman Sachs — with the power to print dollars. (If you can borrow from the Fed at less than ¼ percent, you can effectively print dollars.)

    I do not know who will win this battle between irresistible forces and immovable objects, but I have a pretty good guess who will lose: Anybody with an honest job on either side of the Pacific.

  36. Not sure that the arm race was the most important factor for bringing down the USSR. It was definitely “a factor”. Inability to provide a decent standard of living and defeat in Afghanistan (parcially due to supply of Stringers to Islamic fundamentalists — a really stupid move which Russia wisely did not reciprocate) were probably more important factors. I think that the ideology was dead since WWII and it was just nobody around who can bury the corpse. The system proved to be too economically inefficient to exist. In a way, it was really zombie after 1965 or so. As “Stalin’s comrades” leadership aged and repressions became more and more morally unacceptable the end was in the cards. Country peacefully disintegrated due to internal nationalistic forces (not without support form the West ;-) when ruling elite rejected Tienanmen square solution for the economic crisis. I think that nomenklatura simply decided that they will be better off in a capitalist society and that calculation proved by and large to be true. It was really sad that ordinary Russians suffered so much for their defeat of communism because of economic rape the West committed in 1991-2000 (with Harvard advisers as a fifth column). Clinton in this sense was extremely short-sited president and he missed his chance to create a Marshall plan for Russia and other post Soviet republics which probably would change the situation to much more favorable that it is today at much lower cost that banskers bailouts.

  37. China’s unemployment would go through the roof with a major currency change.Not something their leaders want to face if they don’t have to. Our manufacturing is in capital intense industries.We brushed off the low tech stuff. Plus our oil giants and state department have global visions. Of course shipping costs now are next to nothing which means that Chinese manufacturing may as well be on the mainland, the U.S. mainland.China is here in spirit and at the retail check out cashiers like waves crashing on the shore.
    How do you politely ask them to lay off millions of workers in Chinese? Tough situation , beyond what I know.

  38. “Mr. Obama needs to find a carrot and at least the shadow of a stick, but he really does not want to go anywhere near a trade war (remember the tit-for-tat protectionism of the Great Depression).”

    With a demand constrained economy, protectionism IS MUCH BETTER than becoming a colony of china, but some people cannot admit free trade (as in cheap labor free trade) can be bad.

  39. “But the mainstream consensus is starting to shift towards the idea that the World Trade Organization (WTO), not the IMF, should have jurisdiction over exchange rates.”

    UTTER NONSENSE! Are you going to be looking for a job at the WTO?

    Things like the WTO and IMF are the problems along with the fed.

  40. Next, is the author going to tell us about the “virtues” of one world currency and one world central bank?

  41. There’s a lot of reasons to believe we are at ‘peak China’ now, much as there was a ‘peak Japan’ in the late 80’s.

  42. Dear Simon,

    You mentioned, ‘The President has had considerable diplomatic success on the economic front to date,. . .’

    Is it really true?? or influence of rhetorics.

  43. The comparison between China and Japan seems flawed. Japan ran a huge deficit while China is running a surplus. If we plot China on the BBNN model, we see that it is in the upper quadrant (Surplus + Slightly overheated). That is, it is well positioned to weather the present and future financial crisis. For China, devaluation of the currency will signal a blow to its manufacturing industry. Hence, while Chinese may be polite to cede a 1-2% devaluation to Obama, and further would not be warranted.

  44. If something like this happened in France or Japan it would most likely be that day’s news. Just imagine if a French policeman used a rifle with a sight on it to kill an Arab person in France. Or the amount of riots that would happen inside China if there was video footage of a Chinese businessman being slapped in Tokyo. But it happens in China and even if it makes the news people shrug their shoulders.

    Well, we got our cheap shirt, shoes, and electronics at Wal-Mart. Who cares huh??

  45. Using the current ‘pegging’ arrangement China gains a stable connection between the Chinese Yuan and the international reserve currency (currently approaching $3 trillion). This seems an eminently reasonable and sensible arrangement for China.

    However the international reserve currency also just happens to be our US domestic currency! Would it not be better to have the dollar become effectively two currencies with a floating relationship?

    1, The US domestic currency (called the US dollar)
    2. The international reserve currency (called the ? International dollar? or IMF dollar? or IRC dollar?)

    Sure we gain a major advantage from the two being one, however the problem is not going to go away and a discussion on this issue must surely be overdue?

    The difficulty I forsee will be a refusal by the big banks to even consider this. But the time has come to face the problem. If we make this decision the issue will surely become much easier to resolve and China will not have the prospect of a 20% revaluation becoming a 20% writeoff of their international reserves. If we were faced with a 20% reduction of national worth of say $600 billion (that had to be earned, not found by just printing money) plus an accompanying trade disadvantage, would we not also resist such action?
    What thoughts?

  46. Yes, I know about J -curve. But you still have to deal with the inflation caused by petrol, as it is the one tangible item that everyone has to deal with every time something is moved. It is the one thing that everyone sees from the box of cereal for breakfast, to the gas to go to work, to the Hamburger Helper for dinner especially if we try and move away from it by using grain based ethanol.

    Once you get to a certain wage level, higher petrol it might mean one less meal out or a little less spent on something else, but for those who are just above the poverty level, especially in rural areas where there is no public transportation and you travel 18 miles one way to get to work, buy groceries, and 90 + miles to get to a good shopping centre just to buy your children shoes, unless you want Wal-Mart, it affects purchasing power and you get what we had just 14 months ago — great overseas sales, but the workers could not afford to go to work or they did not pay a bill. The US Economic map showing lateness of credit card debt in rural areas increased with gas prices – my correlation not theirs. I was hoping the BEA in their daft paper GDP and Beyond: Measuring Economic Progress and Sustainability http://www.bea.gov/papers/pdf/RevisedBeyondGDP.pdf would look at this better, but it does not and I have many problems with it i.e. savings rates — a quick chart of savings vs. credit card debt might be a better chart to see along with banks raising the minimum deposit to start a savings account for adults. I get off track.

    Until we have a means of dropping petrol need/cost to low-wage workers or at least buffering their loss of wages in the beginning of the curve, public outcry will prevent the dollar from dropping to where it needs to be to increase exports. I would add that we also run the risk of becoming to dependent on exports like Germany, Japan and others. It might be good policy for the next 20 years, but what happens with population decline afterwards, or are we going to let the 38% of sub-Sahara Africans who want to move to the US, Britain, Canada and France according to a recent Gallup Poll, quoted all over the internet, move north so we do not have to worry about population decline and we can sell to this new group of workers putting off the inevitable for another generation or two.

    StatsGuy, if you were king for a day, how would you handle the start of the downward part of the curve and eventual population decline?

  47. Come on Stats Guy, you are a stats guy and you know you have to throw in Obama and Bernacke with the deficit makers.

    That being said I agree completely that China is perhaps scared to devalue. They have a dicey internal political situation even with the repression. Hundreds of millions of unemployed wandering the countryside can be a daunting problem. And the economic numbers we get from China are only what they want us to see.

  48. Pardon my ignorance Nemo, but how exactly does the job loss scenario play out? I’m not calling you wrong because I honestly wouldn’t know. I’m just curious what actual process you’re referring to.

  49. There’s many more comparisons to be made between China and Russia: A kind of BS middle ground where a central government tries to apply market mechanisms. They want their cake and eat it too. Idiots who have no ability to analyze the situations just look and go “Hey, look those two peoples look physically similar IN MY EYES so that one must be following what happened to that one before.” Freaking brainless.

  50. “(remember the tit-for-tat protectionism of the Great Depression).”
    At that time, the U.S. was the surplus country and so stood to lose the most from a trade war. The opposite is true now.
    If I were responsible for policy in China, getting an agreement to give the WTO authority to deal with issues of exchange rate manipulation is exactly what I would want. The institution is effete and a little bit stupid. It is charged with reducing trade distortions globally, yet by far the biggest and most damaging source of such distortions (currency interventions) is outside of its purview. But it has failed to issue strong and constant complaints about this state of affairs.

  51. The U.S. game is all about re-creating our fake economy of domestic asset bubbles.

    The Chinese game is about preserving the power of that fake U.S. economy to purchase Chinese goods.

    When the whole thing unravels, the massive domestic overcapacity in China will lead to crash with millions unemployed. On the other side, U.S. workers will find their dollars are unusable to purchase stuff they want and need.

    The longer these games continue, the more likely that the outcome will be a crash rather than a slow realignment. In my humble opinion.

  52. The income disparity argument is by far the best argument against devaluation of the dollar, but right now (because of the carry trades) the lower income groups are getting doubly burned – first by unemployment, second by high gas prices since speculators believe the situation is not sustainable in the long term (and are thus using US-provided credit to bet against the dollar).

    With regard to the aging population – in a sense, there are two problems. One is that the Boomers indulged in a fantasy that they could borrow forever, when in fact they should have been lending to developing countries with younger populations to sustain future imports.

    The second is the “demand trap”… there are multiple ways of framing the current “demand” problem. But if you think of this in the context of an aging population, it is entirely rational for individual people to be putting off consumption now to save for old age. The same is true at the national level. The question is what savings at the “national” level means. And it does NOT mean lowering economic activity or using less.

    It means investment – either by lending to countries with younger income groups who will be able to repay (assuming we trust them), OR by investing heavily in very long term infrastructure.

    The “demand” problem is not a demand problem per se. It’s a failure to deploy resources toward very long term investment activities domestically. And it’s a recognition that rather than lending to younger countries, we borrowed, and now when we really _need_ to be borrowing, we are running out of room.

    That really sucks – but the solution still remains the same. Undo the overvaluation of the dollar. And yes, it means we consume less. The real trick is making sure we _invest_ more, and unfortunately our market-based economy has an investment time horizon of 3-5 years. Which means that if we need investments with a 15 year + time horizon (the kind of investments made during the 30s through the 60s), we may need coordinative action to restore the savings/investment equillibrium.

    But that is different from “demand stimulus”. There is a difference between government investment, and government consumption. Running bigger fiscal deficits to sustain consumption is making everything worse. If consumption is the problem, then monetary policy is more effective – even if it requires “unconventional” monetary policy.

    So the answer is a combination of monetary policy (including devaluation) to prevent being swallowed by debt and restore a reasonable level of capacity utilization, structural reform (especially health care and finance), and long term investment support to shift the entire economy toward an investment-economy while consumer demand is retrenching (we do not want an economy where 70% of GDP is sustained by consumer demand).

    On my optimistic days, I think Team Obama “gets it”, but the task is overwhelming.

  53. If you look through my history of comments, I have never defended this administration’s deficit-financed-consumption. I have advocated deficits as an unorthodox mechanism to support monetary policy (IF we used real QE) – a way to inject public money (cash) that reduces the need for private money (e.g. debt). This is inherently self-limiting. I have conceded some need for deficit-financed support during the recent shock, and I have advocated long term government investment (and I do consider certain activities, like supporting education, investment).

    My fear – since I stumbled across this blog a year ago – has always been that we will use deficits to finance consumption as long as possible, thus avoiding inflation/devaluation and structural adjustment, while we slowly sink into a debt spiral we can’t escape.

  54. Simon has essentially discussed this in the context of IMF SDR’s (special drawing rights). China loves the scheme. I think it would be a good idea in the _long run_, since it removes the problem with ascendant currencies suffering inherent overvaluation as trade partners build reserves (which results in long term hollowing out due to excess demand for the currency _itself_).

    The chief concern is that we must ensure that dollar debt does not get converted to SDR debt. If we lose the ability to partially monetize debt through inflation, it is a virtual certainty the US govt will default in entirety.

    Borrowing money in foreign currencies is – in general – incredibly dangerous for a national economy. The mistakes of one generation can result in the debt-slavery of another generation. Think of serfdom on a national scale with overlapping generations.

    Any SDR system must be created with a mechanism for formal debt restructuring (not unlike the US bankruptcy system). All FUTURE lending must be made with the understanding of how debt restructuring will look like.

    Any successful SDR system must therefore be forward looking; it can’t be retrofitted to current debt.

  55. I have a response to this at wpeconomy.com, but I’ll summarize it here. While I agree that the exchange rate is an issue for the U.S., the problem likely won’t be solved by demanding China to reform its policy or integrating exchange rate policy into the WTO framework. China has good reasons to stick to its policy. We have to look inward at our economy to adapt to the changing international environment, especially when, as now with China, we more and more will find that we can’t mold the world to our liking.

  56. Ahhh, ok, I kind of figured the endgame winds up as mutual destruction, but I wasn’t sure if that was the goal of either party or just one possible (inevitable?) consequence of reckless behavior by both parties. So basically it’s a game of chicken between to groups too stupid, proud, or flat out greedy to walk away. “Never attribute to malice that which you can attribute to stupidity”, I suppose.

  57. Statsguy
    Two questions.
    1.Given that other countries borrow in foreign currencies, aren’t you being little precious re us borrowing in non-US currency? Maintaining value of the dollar relative to the other currency means there is no risk.

    2.Monetising debt seems to be a term for destroying our money as a store of value? Just inflate the dollar and we all find our savings purchasing power is diminished?

    Please come up with an alternate fix which protects value of our savings?

  58. As a non-economist, I don’t understand why the United States sold $2 trillion in treasury notes to China. Why were these US treasury notes not sold to American pension funds and local and state governments? Why isn’t China using its trade surplus to develop its own economy?

  59. Simply: They take in 2 trillion and spend 4 trillion. That difference known as the deficit they fund with bond sales. China et al aren’t buying enough, nor is there enough demand home.

    So they print, the fancy name for it is Quantitative Easing. The bond sales are a bit complicated, but recently they have had the primary dealers buy bonds and then the “Fed” (a private bank) stepped in and bought them back.

    Unless the market tanks, I don’t see enough demand for securities. Frankly, at 0% the only demand is that of investors borrowing here and investing else where, what they call the “carry trade.”

    The last thing anyone wants to put there money in is an insolvent currency and one that is yielding 0% interest. a at al are morons who have and are bankrupting this country.

  60. So what if they raised interest rates in the United States?

    Canada (and I take it some EU countries) have had periods of high interest rates and high unemployment. Painful and unpopular. But we did it Canada to bring down our debt and ended up for the better as the world entered this financial crisis.

    As you know, when interest rates tanked, some people were holding bonds bearing double-digit interest rates and they did very well.

    What would be possible scenarios if the US raised its interest rates?

  61. DavosSherman, thanks for your reply. An interesting moniker. Perhaps you are suggesting we need a Sherman at Davos so “save the Union”.

    Perhaps you can help me here. It has occurred to me because labour was so cheap in the developing world, the BRIC countries, huge profits were reaped. So in away the crash of the asset bubble had a logic. There was simply too much money on “one side” in search of a “safe haven” (the AAA-rated bonds). If they had paid more to the workers in the BRIC countries their standard of living would have risen. And perhaps the world financial system would be more stable. What do you think?

  62. I think the last numbers I heard were 24 dollars compared to 1 when it comes to labor. So I think your idea of more pay would have really helped the disparity, and would have been a good thing, indeed.

    I don’t think it would have stopped the asset bubble – as the class that was primarily impacted was that of real estate. Fraud is a big part of this bubble. Fraud with the lenders income and with the rating agencies ratings.

    But you are right, the money needed to come from somewhere. Someone was buying the tranches of sliced and diced toxicity.

    The problem I still see is there are 600 trillion of these these things in the shadow banking system, 200 trillion are in the US.

    This will NOT end well and end it will.

  63. $600 trillion in toxic assets gobally. $200 trillion in the United States. Truly astonishing. Where did you get this number?

    Much of this is worthless paper now. They should have paid more to workers in the developing world.

  64. http://www.occ.treas.gov/ftp/release/2009-34a.pdf refer to table 3. JPMC 87 trillion, BOA 39 trillion, Citi 33 trillion. Those are the 3 biggest the rest (another 22 add up to 200 trillion.)

    Also referred to on Jim Puplava’s fine Financial Sense News Hour Oct 24 3A. A must listen! Select an Audio Format – Part 3
    RealPlayer | WinAmp | Windows Media | Mp3
    Warning: The Next Crisis

    I agree about workers making more! “The Lexis and the Olive Tree” by Friedman, Thomas will no longer work with peak population stressing peak every resource. Sadly the US went insolvent raising the other countries standards as we stripped the world of every resource.

    Future generations will look back at us like we look back at cave men.

  65. Thanks DavosSherman,

    Let’s see … the American derivative market grew $1.5 trillion in the second quarter, TBTF banks are getting bigger, no real political will to regulate Wall Street … foolish would be an understatement.

  66. Yes. Wave 2 of the residential is washing to shore now and mid year next, another 1.5 trillion dollar mess. Coming in with this sludge is 3.5 trillion in CRE. If the dollar doesn’t collapse before this I think we are going to see a 5 trillion dollar punch that will devastate everything, making 2008’s 1.5 trillion punch look like it was delivered by a lightweight.

    Summers, Geithner, Greenspan, Bernanke, Rubin are all absolue m*r*ns.

  67. Davos Sherman write: “Sadly the US went insolvent raising the other countries standards as we stripped the world of every resource.”

    Instead of the phrase, “raising the other countries standards,” suggest — enriching the oligarchy — might be more accurate.

  68. Oh, by the way, that $600,000,000,000,000.00 (600trillion) figure was conservative. Please see ZeroHedges 1,600 trillion dollar upside down (Madoff) Pyramid.


    I haven’t dug into how the Treasury formed it’s table of 600trillion but I know the BEA and BLS cook GDP, CPI, and Unemployment like Enron baked it’s book. Example, you own a home – they add what you would but don’t pay in rent to GDP. They back out Gas and food from Inflation – no consumer can do that.

  69. tippygolden

    If the US were to raise interest rates it would put upward pressure on the dollar. Imports would stay cheap and our exports would stay expensive overseas. So, instead of exporting goods we would continue to export jobs and wealth. The bottom line is that we would continue to destroy our economy.

  70. I can’t see how the $600 trillion could be right. That would mean that 1.3 billion houses were upside down by an average of $450,000. I know there would be a multiplier effect due to credit default swaps and other derivitives, but the $600 trillion is an entire level of magnitude.

  71. “If the US were to raise interest rates it would put upward pressure on the dollar. Imports would stay cheap and our exports would stay expensive overseas”


    Don’t forget what that would do to housing and or CRE or the banks!!!

    The gig is up.

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