China’s currency: Krugman vs. HermanPosted: March 16, 2010
Over the past couple of days, economist Paul Krugman has spent an increasing amount of digital ink on the topic of China’s currency, and in particular, its value and the Chinese governments unwillingness, or intransigence in the face of global pressure to allow the RMB to appreciate naturally against other currencies.
Krugman’s argues that the US, and by default Europe, should turn the tables on China and enact trade penalties should the Chinese continue to forestall a significant appreciation of the RMB.
His argument in favour of punitive measures follows that an appreciation is necessary for the following reasons:
A) As it stands, an unnatural RMB allows for the mass export of Chinese capital which leaves the rest of the world poorer.
B) The appreciation of the RMB would allow for a surge in American exports.
C) America has China over the barrel thanks to the bind the Chinese find themselves given their ownership of trillions in USD reserves.
He finishes his argument by noting that “never before has a nation followed this drastic a mercantilist policy.”
Now setting aside historical precedent, namely the Opium Wars, British attempts to limit manufacturing and industry in its colonies, or more recently, American-led IP conditionality at the WTO, there are a couple of important counter arguments to Krugman’s claims.
First, Krugman explains that Chinese capital exports leave the world poorer by creating a disincentive to invest and thus lower employment and lower demand. However, tightened capital exports are by no means a solution. In fact, if the Chinese stopped buying USD treasuries, the cost of borrowing would increase, leading to a simultaneous drop in investment, employment and demand. Krugman rightly identifies the paradox of thrift at play, yet incorrectly points the finger at the Chinese when the real issue is that the US government (as well as European ones) has failed to properly and adequately fill the investment and financing gap that a structurally-driven long-term recession has created.
Second, while Krugman believes that the appreciation of the RMB would automatically lead to an increase in US exports, thanks to a cheaper USD and thus more expensive Chinese imports / more competitive US exports, history isn’t as clear as he’d make us think. The most relevant comparison for the situation the Chinese and the world finds itself in is likely the early 1980s and the trade surplus amassed by Germany and Japan. As a result, the US forced the 1985 Plaza Accords on both nations, setting off a 40% appreciation in the Japanese Yen.
Low and behold, however, US exports to Japan didn’t budge as a combination of Japanese competition policy and Japanese outsourcing to the rest of Asia, kept US imports out of Japan. Japanese exports to the US didn’t decline either.
Finally, while one can easily understand the long-term impacts of China’s undervalued currency on American and, more broadly speaking, Western economic competitiveness, we might want to put ourselves in the shoes of the Chinese and ask ourselves what we’d do then.
A stronger RMB puts the export-oriented growth that has propelled China since the early 1980s at risk. Given internal targets that place necessary growth at 8 to 10% in order to create enough jobs to forestall social upheaval, any move that seriously risks attaining that growth seems silly enough.
One could argue that bankrupting your biggest consumers in the US and Western Europe is equally silly. Remember, however, that increasingly these markets play a smaller and smaller role in China’s export economy.
In 2008, over fifty percent of China’s exports went to the developing world. Perhaps more important, while exports to the developed world grew by just 10% in the fourth quarter of 2009, they grew by over 50% to India, Brazil, Mexico and ASEAN. As this figure grows with economic growth across Asia, Africa and Latin America, so too will China’s ability to wean itself off of Western consumers.
And finally, while Krugman argues that China is keeping the rest of the world from growing, is that actually oh-so-wrong? The world has long been ruled by those few countries with power. They write the rules, the others follow. That power tends to favour those with strong economies.
Low and behold China is slowly emerging as a rule maker, while the US is gradually losing its ability to dictate global economic policy.
The result is an increasing call from the US for economic fairness, for balance and for a fair chance to compete in global markets.
Yet hasn’t the Third World been calling for the same since the 1970s? Yet unfair trade practices, debilitating conditionalities and significant advantages to US and EU exporters and producers haven’t been altered.
Sure, it’s nice to think that we should all be equal. But equality has never existed. It seems to be against human nature. So perhaps it’s our turn to be on the side of the rule takers while China and others rise to become rule makers.
We certainly won’t like it but if we put ourselves in China’s shoes for an instant we might start to understand why they’re not likely to play nice.