This guest post is by Arvind Subramanian, senior fellow at the Peterson Institute for International Economics.
Yesterday’s announcement by China to introduce greater exchange rate flexibility is unambiguously good news. Greater currency flexibility will help China with its domestic overheating problem. But China deserves a lot of credit for its act of responsible international citizenship, for making its contribution to global re-balancing. Two implications follow.
First, the G-20 deserves a lot of credit for the change in China’s policy. True, Secretary Geithner played his cards skillfully, balancing private chiding with public encouragement. It is also true that recent sabre-rattling by the US Congress to impose trade measures against Chinese exports may have played a role in persuading China. But it is the fact of the G-20 that allowed Secretary Geithner to convert the China currency issue from a bilateral US-China matter (on which little progress had been made for many years) to one in which a broader set of countries had a stake. The public pronouncements by Brazil and India earlier this year re-inforced this “multilateralization” of China’s currency undervaluation. This multilateralization had two positive effects. It forced China to take more seriously the international consequences of its currency policy. And it also made the politics of changing policy easier because China is seen not as caving to bilateral pressure but as responding to the wider international community. Regardless of what happens at the G-20 Summit in Toronto over this week-end, the G-20 can already count the change in China’s currency policy as its victory.
The second implication is this: with China having made its contribution to global re-balancing, it is time to demand the same of Germany, which is the other large surplus country in the world economy, and which has just received a steroidal boost of competitiveness with the decline of the euro. Where China was an intentional mercantilist, Germany has become an accidental mercantilist, which will further increase its current account surplus. But Germany has responded by announcing fiscal consolidation. Some have excused this action on the grounds that the tightening involved would be small and back-loaded. But this misses the key point: Germany’s action has the wrong sign: it should be expanding demand, not just for the sake of global re-balancing but to provide some growth impetus to its dire Southern European neighbors. But in fact it is now reducing demand. If this continues, the spotlight will have to be on Germany. China-bashing is now likely to cede to Germany-bashing.