As William Pesek noted, this week has been “It's beat-up-on-China time.” The specific occasion for the disturbance is that the Treasury has to certify by April 15 whether or not China is a currency manipulator. The Treasury has been finessing the issue for some years now by giving China a pass on these semi-annual reports. This time around, however, there is a good chance they will pull the trigger. At rate, so one might judge from the strange synchrony of editorial opinion on the subject.
When I was a boy in Babylon, everyone knew that the Smoot-Hawley Tariff Act of 1930 was one the misguided measures that made the Great Depression really great. Consensus economists have been saying the same thing for 70 years. But now look what Paul Krugman said in the New York Times Online this Monday:
Widespread complaints that China was manipulating its currency — selling renminbi and buying foreign currencies, so as to keep the renminbi weak and China's exports artificially competitive — began around 2003… Today, China is adding more than $30 billion a month to its $2.4 trillion hoard of reserves. The International Monetary Fund expects China to have a 2010 current surplus of more than $450 billion — 10 times the 2003 figure. This is the most distortionary exchange rate policy any major nation has ever followed.
And it's a policy that seriously damages the rest of the world. Most of the world's large economies are stuck in a liquidity trap — deeply depressed, but unable to generate a recovery by cutting interest rates because the relevant rates are already near zero. China, by engineering an unwarranted trade surplus, is in effect imposing an anti-stimulus on these economies, which they can't offset...
The piece includes an argument to the effect that, contrary to widespread opinion, the United States and China are not in a position of mutually assured economic destruction. In the event of a trade war, the United States would just win; any action with which China can really threaten the United States financially would lower the value of the dollar relative to the yuan, which is the goal of American policy. The author therefore feels secure in making this recommendation:
In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10 percent surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies. At this point, it's hard to see China changing its policies unless faced with the threat of similar action — except that this time the surcharge would have to be much larger, say 25 percent.
A point about Smoot-Hawley: the oddest thing about it was that it did more damage to the United States than it did to the United States' trading partners. In a trade war, it's the combatant that had been running a surplus that is more hurt.
But perhaps you would like more diagnosis before the surgery? Or maybe more evidence before the execution? Who better than one of the men who proved that hedge funds are mortal?
China is in the midst of “the greatest bubble in history,” said James Rickards, former general counsel of hedge fund Long-Term Capital Management LP.
The Chinese central bank's balance sheet resembles that of a hedge fund buying dollars and short-selling the yuan, said Rickards, now the senior managing director for market intelligence at McLean, Virginia-based consulting firm Omnis Inc...
Rickards said leveraged speculation in the stock market, wasteful allocation of resources by state-owned enterprises, off-balance-sheet debt through regional governments and the country's human rights record are concerns.
“Take Russia and China together, neither of them is really deserving any investment” except for short-term speculation, Rickards said. India and Brazil are two of the “real economies” among the developing countries, he said.
To be fair, the Chinese government is perfectly aware that its measures to prevent a complete implosion during the financial crisis made a badly overleveraged economic environment much worse. As the ever gloomy Gordon Change argues, some of the measures the government is taking now will simply shift the risk:
In recent days China's central officials have stated they will nullify all guarantees that had been issued by local governments to support loans to special purpose financing vehicles.
China's Budget Law prohibits Chinese provinces and lower-tier governments from borrowing. To get around the restriction, local officials established more than 3,000 companies to borrow, with their loans typically supported by governmental promises in some form. The Budget Law also prohibits this maneuver, but it has been practiced openly for years.
[R]ural governments ended up in a pinch because the central government had, to its credit, ended the hated agricultural tax and other fees in order to relieve peasants of onerous financial burdens. Premier Wen Jiabao, however, offered local governments little financial compensation for the loss of crucial revenues. Unfunded mandates from Beijing just aggravated the problem. Municipalities, consequently, borrowed to provide necessary services…. Northwestern's Victor Shih notes that recent official figures are, in reality, mere guesses. He estimates local-government entities borrowed $1.6 trillion from 2004 to the end of last year….
Of course, there is one complication after such a massive surge of lending. Many of the new loans will end up as nonperforming assets on the books of the state banks. It is not possible to create a tidal flood of liquidity without overwhelming lending standards, especially when local governments indulged themselves by starting so-called “beauty-show projects” that had little economic viability.
[S]o when Beijing gets around to nullifying the illegal guarantees, we will see a shifting of losses from local governments to state banks. Why would the central government move the losses from one group of state entities to another? The state banks now have private shareholders, many of them foreigners. That means outsiders will end up bearing substantial losses.
There is no reason to doubt that the Chinese government would revalue substantially if it could. However, the consequences of doing such a thing badly or precipitously can be very regrettable:
North Korea has executed a ruling party official blamed for the botched currency reform last November which led to runaway inflation and threatened new food shortages, in what is an attempt to contain civil unrest.
Pak Nam-ki, the 77-year-old head of planning and finance, was executed by firing squad in Pyongyang last week according to South Korea's Yonhap news agency… In the capital, Pyongyang, yesterday only the few shops and restaurants permitted to trade in foreign currencies — patronised by the privileged elite and the city's small foreign population — were open for business.
All other enterprises and services based on cash, including markets, long-distance bus services, barbers' shops, saunas and bath houses, were suspended until the revaluation of the won is completed next week.
And then of course there is also the matter of national pride, or at least of not looking foolish before the Chinese public. The Part Line is that it is China that has cause to be aggrieved:
A commentary in the official China Daily, "Like the Na'vi, we'll decide, thanks," on Thursday blasted the critics of China's currency policy, comparing them to the greedy corporation ripping apart the planet of Pandora in James Cameron's 3-D epic.
"The sound and fury in the United States over China's valuation of the yuan reminds me of nothing so much as a scene in Avatar in which the soldiers from Earth prepare to destroy the Tree of Souls on Pandora," wrote commentator Li Xing.
The Chinese do have a point. They had been buying American securities of all kinds all these years, only to find out in 2008 that the securities were the offspring of fantasy and fraud. This point, however, does nothing to mitigate the fact that the Chinese had been running a predatory mercantilist policy long before the US financial system leveraged itself to death. For China to complain now is like Charles Ponzi complaining that an investor had given him a bad check.
Whatever America's own failings, the United States still has to decide what to do to close the Chinese Ponzi scheme down. It has to be done now, because the US economy is starting to pick up, and the continuation of China's mercantilist policy would simply drain away the potential for domestic growth.
William Pesek, whom we quoted above, agrees that something must be done, but does not think the United States is the proper party to do it:
China isn't going to boost the yuan because U.S. Treasury Secretary Timothy Geithner wants it. It's not going to hobble its export juggernaut because Nobel Prize winner Paul Krugman wants it. The U.S., let's face it, has zero moral high ground when it comes to the state of global imbalances.
Things will be very different when the griping comes from places such as Thailand, Indonesia, Singapore or Vietnam. And that gets at the central question: Why isn't the developing world speaking out? It certainly should be. Until it does, don't expect big moves on the yuan.
Trade isn't supposed to be a zero-sum game, yet China's undervalued currency is making it one. Rather than pumping growth into fellow emerging economies, China's policies are hogging it.
The world is upside down. Ten years ago, this would have been handled by the global economy's core: the Group of Seven nations. This time, the core is rotten and outer crust is the engine keeping world commerce alive. The yuan is a job for China's peer economies, not those that caused the turmoil.
Precisely why we should expect China to pay attention to its developing neighbors is a little mysterious. To the extent that China is a still a developing country, it is in competition to with other developing countries. If they complain, would that not be a sign of success? And if they don't complain, that is some evidence that they are intimidated by an uppity China during an episode in which the American government seems inclined to act as if the United States were just another country.
Meanwhile, getting a jump on 1914 nostalgia, Ambrose Evans-Pritchard asked in the Telegraph of London's blogs this week: Is China's Politburo spoiling for a showdown with America?
China has succumbed to hubris. It has mistaken the soft diplomacy of Barack Obama for weakness, mistaken the US credit crisis for decline, and mistaken its own mercantilist bubble for ascendancy. There are echoes of Anglo-German spats before the First World War, when Wilhelmine Berlin so badly misjudged the strategic balance of power and over-played its hand…. 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.
I let others discuss the rights and wrongs of this, itself a response to the US report card on China. Clearly, Beijing is in denial about is own part in the global imbalances behind the credit crisis, specifically by running structural trade surpluses, and driving down long rates through dollar and euro bond purchases. No doubt the West has made a hash of things, but the Chinese view of events is twisted to the point of delusional.
What interests me is Beijing's willingness to up the ante. It has vowed sanctions against any US firm that takes part in a $6.4bn weapons contract for Taiwan, a threat to ban Boeing from China and a new level of escalation in the Taiwan dispute.
Healthcare, you say? At this point in 1914 everybody in England was talking about Irish Home Rule.
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