China is holding down the value of its currency, which means goods made in the country cost less everywhere else. This undercuts American companies that make things, so they close factories here and buy from there. This costs us jobs, forces down our wages and savings rate, and forces the country to borrow heavily. This imbalance has built up to a breaking point. It is past time to face facts and something about it.
Just how much is China undervaluing their currency? Paul Krugman today: "This is the most distortionary exchange rate policy any major nation has ever followed." Yes, that much. And the result? Krugman says: "And it's a policy that seriously damages the rest of the world."
A NY Times story yesterday explained how it works,
China buys dollars and other foreign currencies -- worth several hundred billion dollars a year -- by selling more of its own currency, which then depresses its value. That intervention helped Chinese exports to surge 46 percent in February compared with a year earlier.
This creates a huge, huge -- and growing -- imbalance. China undercuts everyone else so they can't afford to manufacture and have to buy things made there instead. Of course, that means China is sitting on massive piles of foreign cash. This is a bubble that grows and grows and grows. Everyone is worried, and it just gets worse.
But China won't change policies. They are worried that the value of that pile will drop if their currency rate rises. In Pledge to China's Leaders: You Will Lose Money on Government Bonds Dean Baker writes about why this would be great for us,
The logic is very simple. At the current exchange rate, the United States is running a massive trade deficit...
This is of course unsustainable. The only way that this deficit can be corrected is by reducing the value of the dollar...
... We should beg them to become unhappy with our fiscal and monetary policies and stop investing in Treasury bonds. The improvement in the trade deficit that will result from the fall in the dollar will create ten times as many jobs as any "jobs bill" that President Obama can possibly get through Congress.
Does all of this cash give China enormous power? In Is China's Politburo spoiling for a showdown with America? Ambrose Evans-Pritchard writes,
Michael Pettis from Beijing University argues that China's reserves of $2.4 trillion -- arguably $3 trillion -- are a sign of weakness, not strength. Only twice before in modern history has a country amassed such a stash equal to 5pc-6pc of global GDP: the US in the 1920s, and Japan in the 1980s. Each time preceeded depression.
The reserves cannot be used internally to support China's economy. They are dead weight, beyond any level needed for macro-credibility. Indeed, they are the ultimate indictment of China's dysfunctional strategy, which is to buy $30bn to $40bn of foreign bonds every month to hold down the yuan, refusing to let the economy adjust to trade realities. The result is over-investment in plant, flooding the world with goods at wafer-thin export margins. China's over-capacity in steel is now greater than Europe's output.
Change is in the air. The establishment is moving -- recognizing that we will have to confront this. Dealing with this currency manipulation is the bipartisan solution that creates 3 milion jobs and costs us nothing. How bipartisan is it? Last Week conservative Pat Buchanan wrote about what he called China's "disemboweling of America" and I agreed. I wrote,
So, this "free trade" stuff has worked out for us about as well as the "free market" stuff worked out for the economy. Free market and deregulation ideology destroyed the economy. Free trade has destroyed our ability to earn money and recover from the destruction of the economy.
The lesson to learn is if you want more jobs and don't think we should have so much debt then you want a China to raise the value of its currency against the dollar. America has avoided formally labeling China a currency manipulator and taking appropriate steps, so things continue to get worse. We can't keep hiding from reality forever. When something is unsustainable it can't be sustained.
Next month the administration is going to have to change directions. A lot of air will come out of that Chinese currency bubble that was allowed to build up over the past several years, but the result will be a world starting to return to balance -- and jobs here.