May 1, 2012

U.S. Asks China Not to Destroy World Economy

As efforts to contain economic damage stumble,  fail, around the world , it's time to revisit a post from November 2009.   I've updated with a few notes added in blue (below).  China's sustained effort to increase its exports through subsidies (via its currency peg/manipulation) -- which also raises the prices of American goods in China -- have greatly worsened devastating global trade imbalances.

The effect of these gigantic trade surpluses are widespread joblessness and gradual economic collapse in the western world.

But global trade imbalances maintained by currency pegs, like stress in the earth, must eventually release.  We now are witnessing the escalating quakes in Europe as both austerity and ability to borrow are failing.  These are like the little tremors and the medium sized tremors before the big one.

One wonders how long China will drag its feet to rebalance its own economy as the world economy falters.  Will it wait until exports collapse and it sees riots in its own cities?

But then, rarely are people willing to realize, to comprehend, the harmful effects of actions they believe benefit themselves, especially if the illusion can be maintained a little longer....

They don't want to know that their export model is slowly destroying the world economy, via their sheer size and manufacturing investment. Not any more than Germans would like to understand that their prosperity has come in large part from a currency peg against the rest of Europe via the EMU (European monetary union -- the Euro).  Were a (reestablished) German Deutsche Mark and the Chinese Renminbi allowed to freely float, so that their exchange rates were freely set by markets, nations like Greece, Italy, Ireland, Portugal, Spain, the U.K....and the U.S., to name a few, would quickly feel a fresh breeze of new economic activity and hope.

In fact, we could change course away from a very dark future (see this post).

But Germany has experienced record low unemployment (as the world economy deteriorates).  Why would Germans want to recognize reality?


November, 2009:

Finally, after years, even economists like Krugman are publicly recognizing that the Chinese peg of their currency to the dollar is more than a nuisance or a developing-country tactic. It's a profound handicap placed on American manufacturing.

(2012: During the last year, the understanding of the effects of the Chinese peg has become widespread.)

The peg threatens American recovery. It is in effect a Chinese trade war against America, ongoing for years.

Many economists haven't yet really wrapped their minds around the reality that if exports are heavily subsidized (relative price held down) by a currency peg during an imbalance, then it is no longer "free trade."

We do not have free trade with China.

"Free trade" is effectively an ideology in recent times. Economists understand the advantages of free trade -- how it increases most everyone's absolute wealth (buying power in goods). It's understood the disruption and economic damage the raising of trade barriers would cause. All true.

But not enough. The thinking simply needs to continue beyond this basic level of understanding.

When a government intentionally bends a nation to accomplish an international goal of gaining manufacturing jobs at the expense of other nations (at the expense of jobs in other nations), this is a kind of powerful trade interference. It becomes in effect a trade war.

Damage to the U.S. isn't the only result of this managed effort. The peg actually threatens Chinese stability by extending a reliance on an unsustainable imbalance.

But more, the Chinese peg threats global economic stability.

(2012: Witness Europe)

And that raises an open question.

Does China have the smarts to recognize that both alternatives that could follow from maintaining the currency peg are quite harmful to China itself?

It's a multi-trillion dollar question.

Here are the two alternative scenarios I see if China maintains the peg.


A) As Martin Wolf points out, the U.S. is truly forced, without choice, to initiate major tariffs within a few years:
“Yet we do not have that much time. If the US domestic economy remained weak and unemployment high, while our trade deficit soared, particularly our bilateral deficit with China, the pressure to ‘do something’ would become irresistible. I would have to consider the sort of actions that Richard Nixon took in 1971. To force revaluations by Germany and Japan, he threatened a 10 per cent import surcharge. With great regret, I might feel obliged to do the same. I would then argue that China’s determination to thwart needed adjustment in exchange rates had become intolerable. The US is entitled to protect itself against such mercantilism. The trading system would be terribly damaged. But the alternative would be unbearable.”


B) If somehow the U.S. government delayed such a response for little longer based on "free trade" fallacies, then the buildup of political pressure in the U.S. due to joblessness would only lead to a more drastic final U.S. response than the one Martin suggests.

Ideology -- the mental error of trying to maintain "free trade" when the U.S. faces in reality a kind of ongoing trade war -- can only withstand a contrary reality up to a certain limit, at which point the ideology, or illusion, collapses and great political energy is released. America could actually be pushed into a genuine change in ideology.

China by nature should be a natural ally of the U.S. Only the paranoid right has needed to see China as a serious rival.

That could change.

So this question is really a question of smarts. Are they smart enough to see the train coming down the track? Are we smart enough to sound the horn instead of patiently waiting for China to answer a diffident phone call?

It has become evident that conditions similar to the 1930s could arise... (2012 update: have arrived.  We have economic depression in several nations in Europe now, and are seeing a dramatic rise of nationalism.  We are progressing on the list towards a much darker time I reluctantly laid out in the link above.)  ... if these trade imbalances persist, which could lead to a increased risk of economic wars and even a general destabilization of currently peaceful parts of the world, with risk of major warfare.

Update (2010):
Cui Tiankai, a Chinese vice foreign minister who is in charge of preparing for the G20 summit, said the yuan was "China's currency, so I don't think it is an issue that should be discussed internationally.
Regardless of internal Chinese politics/signals, the exchange rate of the yuan to the U.S. dollar, which China is massively intervening to control, is with the U.S. dollar and directly intervenes in U.S. exports by controlling U.S. export prices to China and many nations.

China is controlling U.S. export prices by directly controlling the value of the U.S. dollar.

Is that an "international" issue? Yes.

The U.S. dollar is the currency of the United States, so interventions that affect the dollar are central to U.S. economic health, and fully within the purview of the federal government of the United States.

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