Despite the Obama administration's desperate efforts to keep the issue off the boil, Chinese currency manipulation is back in the news again. Treasury Secretary Timothy Geithner just politely postponed his official report on the question, and Beijing seems to have responded to this courtesy by hinting that it may allow some token appreciation in its currency.
For those readers who have been under a rock for the last few years, the problem is that China artificially lowers the price of its currency, the yuan, in dollars in order to make its exports cheaper in this country. This is one major reason why China is running a huge trade surplus with the U.S.--around 80 percent of our non-oil trade deficit in 2009 and over 100 percent of our deficit in technology (i.e. we run a surplus against the rest of the world).
Unfortunately, the token appreciation that is probably now in store won't help very much. For one thing, Beijing has played this game before. China first started diversifying its currency reserves away from the dollar (which weakens currency manipulation) in July 2005, and from then until July 2008 allowed the yuan to rise from 8.28 to the dollar to 6.83, where it has since been held nearly steady. But this appreciation, while showcased by China, was purely nominal; after adjusting for inflation, the change was far smaller: about two percent.
How does China manipulate its currency? Mainly by preventing its exporters from using the dollars they earn as they wish. Instead, they are required to swap them for domestic currency at China's central bank, which then "sterilizes" them by spending them on U.S. Treasury securities (and increasingly other, higher-yielding, investments) rather than U.S. goods. As a result, the price of dollars is propped up--which means the price of yuan is pushed down--by a demand for dollars which doesn't involve buying American exports.
The amounts involved are astronomical: as of 2008, China's accumulated dollar-denominated holdings amounted to $1.7 trillion, an astonishing 40 percent of China's GDP. The China Currency Coalition estimated in 2005 that the yuan was undervalued by 40 percent; past scholarly estimates have ranged from 10 to 75 percent.
Why is this America's fault? Because China's currency is manipulated relative to our own only because we permit it, as there is no law requiring us to sell China our bonds and other assets. We could, in fact, end this manipulation at will. All we would need to do is bar China's purchases--or just tax them to death.
This would be neither an extreme nor an unprecedented move. It is roughly what the Swiss did in 1972, when economic troubles elsewhere in the world generated an excessive flow of money seeking refuge in Swiss franc-denominated assets. This drove up the value of the franc and threatened to make Swiss manufacturing internationally uncompetitive. To prevent this, the Swiss government imposed a number of measures to dampen foreign investment demand for francs, including a ban on the sale of franc-denominated bonds, securities, and real estate to foreigners. Problem solved. (It did not even damage Switzerland's standing as an international financial center, a key worry at the time.)
If Chinese currency manipulation is so easy to stop, why haven't we done something about it long ago? Mainly because if China ever did stop bingeing on American debt, this would entail it ceasing to ship hundreds of billions of dollars per year of (quite cheap, as it mostly gets the low interest rate paid on government bonds) capital to the U.S. If we didn't then raise our abysmal savings rate to take up the slack, this would sharply raise our interest rates by the operation of supply and demand for capital.
So the real underlying problem is that America doesn't generate enough savings on its own to meet its voracious appetite for borrowing. China's savings rate, thanks to deliberate suppression by the Chinese government of its people's opportunities to spend what they earn, is an astonishing 50 percent. Ours was negative four percent in the last Federal Reserve report on the subject. We are--Oh, how Mao would have loved this!--decadent.
As a result, it is our own inability to raise our savings rate that is the binding constraint here, not anything China does or does not do. We should indeed end China's currency manipulation, but this is something we must do for ourselves, not twist China's arm to do. (Ironically, China is probably doing us a favor by not giving in to our pressure until we are ready to handle the consequences.)
To get out of our currency trap, we need to either save more, borrow less, or both. Unfortunately, the current trillion-dollar-deficit tax and spending plans of the Obama administration aren't exactly putting us on this path. Until the administration gets serious here and the private sector follows suit, our helpless addiction to foreign capital will continue to positively invite currency manipulation. It's time for America to stop whining on this one.
Ian Fletcher is the author of Free Trade Doesn't Work: What Should Replace It and Why (USBIC, $24.95) He is an Adjunct Fellow at the San Francisco office of the U.S. Business and Industry Council, a Washington think tank founded in 1933. He was previously an economist in private practice, mostly serving hedge funds and private equity firms. He may be contacted at email@example.com.
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