Storm, The (17 page)
The complaint about China’s ‘unfair’ exchange rate is, however, wrong on a basic point of economics. What matters for the
‘competitiveness’ of exchange rates is not the nominal value, but the real effective value when relative rates of inflation
and the exchange rates of trading partners are taken into account. Chinese inflation is difficult to measure but is undeniably
more rapid than in the USA, causing a real appreciation against the dollar. And
when the dollar has appreciated against other currencies, it has taken the Chinese currency with it; in the period 1994–2001,
it is estimated that China experienced a real effective appreciation of 35 per cent. Yet exports boomed, including in those
markets where China experienced a loss of competitiveness (80 per cent of Chinese exports go outside the USA).
The reasons why China has sought to maintain a currency peg with the USA are only partly to do with export-promoting, mercantilist
thinking. China has, as a result of years of current account surpluses and flows of direct foreign investment from multinational
companies, acquired vast foreign exchange reserves, estimated at $1.8 trillion – out of a world total of just $7 trillion
– mostly in the form of dollar assets. A currency appreciation against the dollar would have the effect of inflicting a large
capital loss on China. Thus the dependence of the USA on China is mutual: the economic equivalent of mutually assured destruction.
Were the Chinese abruptly to change their exchange rate strategy, as some American politicians demand, not only would it suffer
a capital loss on its reserves but it could perhaps precipitate a disorderly collapse in the value of the dollar, with unpredictable
consequences. So, in practice, it has agreed to a gentle, gradual, managed appreciation. Until December 2008 there were grounds
for believing that the problem would be quietly resolved in this way. But then, panicking in the face of a sudden slowdown
in exports and economic growth, consequent upon the global recession, the Chinese authorities effected a devaluation – reigniting
the whole incendiary issue of exchange rate policy.
There are other reasons why the problems around the exchange rate may not be easily managed. One of these is that the underlying
problems have relatively little to do with China and more to do with what Martin Wolf has called the ‘exorbitant privilege’
enjoyed by the US dollar. The ability of the USA to borrow abroad in its own currency, because it is the global trading currency,
confers considerable advantages. These include the ability to acquire imported consumer goods and to sustain a large overseas
military presence by, in effect, printing dollars. The Chinese are increasingly questioning the hegemonic role that the US
enjoys as a result of this privilege, but the more pluralistic world they envisage represents a profound challenge to a world
order that has existed for six decades.
As for China itself, as it becomes fully integrated into the world economy it will experience the same loss of national control
over its domestic economy that Western capitalist economies have experienced. In technical terms, it can control its exchange
rate or its monetary policy, but not both. While the USA and UK have opted for control of monetary policy and let their exchange
rates float, China is trying to do the opposite. What is happening is that foreign reserves build up as a result of the Chinese
central bank buying dollars in order to keep the exchange rate down. These reserves then feed through into an expansion of
domestic money supply, which pushes up inflation. Specifically, what happens is that as the central bank buys large quantities
of dollars it has to pay in its own currency. It then tries to ‘sterilize’ the increase in money supply by issuing a lot of
government securities which are then ‘parked’ with Chinese banks. As China becomes a capitalist economy no longer governed
by commands, banks have to have an incentive to hold these assets: this comes in the form of higher interest rates. If sterilization
is successful, inflation is curtailed but foreign exchange reserves pile up – in China’s case to well beyond the level needed
for any conceivable shock. As interest rates increase to counter inflation, capital is attracted into China – ‘hot money’
– which requires even greater intervention, creating even more liquidity, and pushing up inflation. China is still theoretically
a communist country and has capital controls, backed up ultimately by firing squads. But these no longer deter flows of capital,
which operate through many subtle financial mechanisms, including over- or under-invoicing of trade and foreign investment
transactions. Exchange rates therefore become, as they are for Britain or the USA, not independent tools of policy, but dependent
on wider monetary policy.
One of two things can now happen. The first is for the Chinese to abandon their current policy, let the exchange rate float,
accept big losses on their reserves, and reassert control over domestic monetary policy and inflation. This is the fantasy
outcome of their US critics. But these critics should perhaps be careful what they wish for, since the result might well be
a serious slowing of the Chinese economy at a time when the rest of the world economy is barely recovering from recession.
And a big sale of their dollar assets by the Chinese – and other big reserve holders fearing a dollar devaluation – would
force down the dollar, perhaps in a disorderly way.
The other, more likely, alternative is an attempted continuation of the status quo: holding down the Chinese currency. The
status quo, however, has been fuelling inflation and monetary instability in China. It is also increasing tensions with the
USA, which may now be aggravated by the recession there and anxiety about jobs, and spill over into protectionism. There has
already been openly expressed resentment of Chinese (and other foreign) countries trying to improve their returns on dollar
assets by switching into the purchase of American companies.
Those with long memories will recall that in 1971 the first Bretton Woods system broke down when the Nixon administration
imposed an import surcharge and forced a currency appreciation on its main trading partners, aimed particularly at Germany
and Japan. The USA may be tempted to try something similar again. President Obama has made commitments to labour unions to
act tough on trade matters. An apparently minor trade dispute with China over tyres imported into the USA has recently been
fuelled by the Obama administration and has the potential to escalate. Nor is the problem limited to the USA. A recent Harris
poll suggested that almost 50 per cent of Italians and a third of French and Germans think that, for a mixture of political
and economic reasons, China is ‘the greatest threat to stability’. China ranked far ahead of Iran and other more plausible
candidates. Indeed, the European dimension is perhaps not
receiving adequate attention. If the USA stabilizes its current account deficit and the major Asian economies maintain their
dollar exchange rates, then the burden of adjustment will fall on an appreciating euro. The strains are being felt not least
in the relatively inflexible eurozone countries, which are struggling already to adjust to imbalances within the eurozone,
notably Italy and other countries in southern Europe. It is not a coincidence that the most stridently anti-Chinese, and protectionist,
noises are coming from semi-Fascists in the Italian government as well as US Democratic Congressmen.
The focus on China has also deflected attention from the other major source of surplus savings, the Middle Eastern oil exporters
and Russia. The Gulf States also peg their currencies to the dollar, with consequences similar to those in China – not least
growing inflation as a consequence of, in effect, adopting US monetary policy. But they are also different from China in that
foreign assets are often privately owned, and hidden. They differ, too, in that their economies depend upon oil exports, and
the collapse in oil prices that we have seen in the latter part of 2008 may make their surplus savings short-lived.
It may have been convenient for a while to allow the USA, the UK and other developed countries to finance their economic growth
from overseas savings. And it may have been convenient for China (and some other emerging economies) to sustain short-term
growth based on exports (and inward direct investment) by exporting savings and running large current account surpluses. Both
take credit for the boom, and both must take part of the blame for the slump that has followed. Moreover, such an arrangement
is perverse and has been giving rise to growing tensions.
The USA is already adjusting under pressure of recession with a falling current account deficit. China will have to adjust
in parallel or there is a risk that the tensions could break out into trade warfare. In other words, the USA cannot diminish
its excess spending unless China – and others – diminish their excess savings. To do so
would not be some act of philanthropy towards the USA. It would simply be sensible. Indeed, it is positively wicked for the
government of a poor country to insist so stubbornly on the necessity of continuing to lend money to a very rich country rather
than spending the money at home. What is needed is for the Chinese communists to behave more like communists and spend Chinese
savings on social goods like healthcare and pensions instead of insisting on the privatization of these services. There is
some sign that this is exactly what is happening, with the announcement of a vast programme of medical insurance for rural
China.
The world resembles an
Alice in Wonderland
tea party in that everything is the opposite of what it should be. Poor countries provide foreign aid to rich countries to
help them live a riotous lifestyle. Rich countries then become angry that they are being forced to accept aid from poor countries
and argue that this state of affairs is desperately unfair – not to the poor countries, but to themselves. Poor countries
complain, in turn, about being bullied into stopping this flow of foreign aid from their own people who need it to foreigners
who don’t.
But this world is positively rational compared to the mad, mad world of trade policy. The main trading countries have been
locked for several years in negotiations that centre on the following proposition: you agree to stop shooting yourself in
the foot by paying out subsidies and hurting your consumers through costly import restrictions, and we shall, reluctantly,
do the same. Or, more accurately, if you refuse to stop shooting yourself in the foot, we shall also refuse to and, indeed,
shoot ourselves in both feet, just to show that we are more serious. Such is the strange logic of ‘reciprocity’, the process
by which liberalization of world trade proceeds – or, at present, doesn’t. I parody only a little.
There are some plausible arguments for trade restrictions: to turn the terms of trade to advantage; or, more controversially,
to protect ‘infant industries’. But neither of these considerations is
central to the current round of global negotiations, which have focused essentially on three issues: the need to produce some
rules limiting the use of subsidies and trade restrictions in agriculture; the incorporation of emerging economies like China,
India and Brazil into the processes of bargaining and reciprocal consensus that make up the trade negotiating process; and,
as in every previous round of trade negotiations, to provide some forward momentum behind liberalization. The fear is that,
without liberalization, the world might revert to the beggar-my-neighbour protectionism which didn’t cause, but almost certainly
deepened, the Great Depression.
The present round of negotiations was launched in the wake of 11 September 2001 and was designed to breathe optimism into
the world economy when there was a fear that confidence would collapse. Seven years later, after repeated attempts to bring
the negotiations to a satisfactory conclusion, they appear finally to have failed. The current global crisis, with its echoes
of inter-war financial disorder, has made success in the negotiations more necessary but also more difficult.
The central issue in the negotiations has been agriculture, long insulated from post-war liberalization by the remarkable
capacity of relatively small and dwindling numbers of farmers to hold governments political hostage in the EU, the USA and
Japan. Some, limited, progress was made in earlier rounds of trade negotiations in isolating subsidies that are ‘trade distorting’
– that is, export subsidies – but in this round little progress has been made to reduce subsidies on an agreed basis or to
reduce market access barriers. For this reason, there are potentially much larger gains from agricultural liberalization than
anywhere else. One estimate is that a radical liberalization package would lead to a global economic benefit of $300 billion
a year by 2015, even without additional productivity gains from competition. Agriculture accounts for 60 per cent of the potential
benefits of the round, although agriculture and food processing account for under 10 per cent of world trade and 4 per cent
of world GDP (albeit for
a substantial majority of the world’s population, if subsistence farmers were to be included).
