President Obama will go to Asia next week and has promised to say something about the exchange rate between the Chinese yuan and the U.S. dollar. It would be good if some enterprising journalist asked him why the United States is worried about the Chinese dumping their dollars, and why U.S. Treasury Secretary Tim Geithner recently said that the United States is committed to a "strong dollar." As a matter of accounting, a "strong dollar" is the same as an "undervalued yuan." So it makes no sense to be worried about the great "power" that the Chinese are holding over us -- that they can dump a few hundred billion dollars of their reserve holdings and cause the dollar to fall.
A fall in the dollar would be just what Obama and others are asking for when they ask the Chinese to allow their own currency to rise. This would stimulate the U.S. economy by reducing our trade deficit. It is also just what we need to resolve the long-term problem that our trade deficit represents. Although the U.S. trade deficit has been cut in half during the current recession, it will once again swell as the economy recovers unless the dollar is reduced to a more competitive level and stays there.
The manufacturing sector of the United States, including the National Association of Manufacturers and some union leaders, understand this very well. But they have relatively little political clout. The interests that dominate economic policy-making in the United States are mainly in the financial sector, as we can see by the hundreds of billions of dollars of no-strings-attached government subsidies they have gotten in this recession; and the $21 billion in executive compensation that will be paid out by Goldman-Sachs, which is particularly well represented in our government. A strong dollar is good for them because it makes anything they want to buy overseas cheaper, and of course it lowers inflation by keeping imports cheaper. The more than five million manufacturing jobs lost over the last decade are just "collateral damage" for them.
Since this conflict of interest between Wall Street and the rest of the country has been resolved in favor of the guys with the big bonuses, what we end up with is a spectacle of scapegoating. It is cheap and easy to blame the Chinese for the overvalued U.S. dollar (which is official U.S. policy) and the U.S. trade deficit. While it is true that the Chinese could allow their currency to rise against the dollar, it is also true that the United States Treasury has the ability to influence the international value of our own currency - just like China and many other countries do. Although the Chinese currency is not freely convertible, our government could push down the dollar against other major currencies, which would generate more pressure on the Chinese currency. It is also worth noting, as World Bank Chief Economist Lin Yifu pointed out this week, that only about one-third of the U.S. trade deficit for the years 1990-2007 is with China.
With respect to the Chinese holdings of dollar-denominated assets, China is holding a lot of longer-term U.S. government bonds (e.g. U.S. ten-year treasuries). If the Chinese government were to sell off a lot of these, it would drive up long-term interest rates in the U.S. Since our mortgage rates and other long-term lending rates tend to move with long-term Treasuries, this could obviously have a negative impact on the U.S. economy.
But it must be emphasized that this is a different issue from the dollar falling. Is this threat of a Chinese sell-off of longer-term U.S. treasuries something that we should worry about? Not really. First, the Chinese government does not want to hurt the U.S. economy, which still absorbs about 20 percent of Chinese exports. One reason that they have accumulated long-term Treasuries was to help push down long-term rates in the U.S., to support growth and demand for their exports during the 2001-2007 expansion in the U.S. (Some economists have even tried to blame the Chinese for the housing bubble, since these purchases helped push mortgage rates down during the bubble years. But the housing bubble was, even more than the overvalued dollar, a result of deliberate U.S. policy.) Second, the Fed can counter-act unwanted increases in long-term treasury and mortgage rates, as it has already done during this recession.
Deficit hawks and other fear-mongers in the U.S. have also used the Chinese accumulation of U.S. debt as another weapon to try and persuade people that we must sacrifice growth and employment during a deep recession, in order to avoid further debt accumulation. This too, is a dangerous misconception. Unfortunately our economic problems are made in the United States, and it is here in Washington that they will need to be fixed.
This column was published by The Guardian Unlimited on November 12, 2009.