Dr. Mankiw labels complaints about China’s practice of intervening in the market to hold its currency down protectionist.
But Mankiw isn’t defending a world where governments do not intervene to shape trade flows.
An undervalued exchange rate acts as a subsidy for that country’s exports – and it also protects its domestic producers from competition from imports. Ask Dr. Bernanke. Dr. Subramanian of the Peterson Institute writes: “An undervalued exchange rate is in effect a combination of export subsidies and import tariffs.”
China’s exports would not have grown as fast as they have – goods exports went from $250 billion in 2000 to $1430 billion in 2008 – if China hadn’t added about $2 trillion to its reserves over this period. If the RMB hadn’t say depreciated against the euro over this time period, I rather doubt that China’s exports to Europe would have grown even faster than China’s exports to the US. The weak RMB also created incentives to produce goods in China that might otherwise have been imported, including a lot of the components for China’s exports.
Mankiw effectively is arguing that the US benefits from China’s intervention in the market, and consequently shouldn’t object to China’s export subsidy. Europe presumably is in the same boat.
China cannot subsidize its exports without also subsidizing US consumption of Chinese goods – and US borrowing. Of course, some in the US are on the losing end of the “low-priced Chinese goods for high-priced US government bond” trade – and those losses aren’t equally distributed. Some parts of the country tend to produce more goods than compete with Chinese goods than others. But the US as a whole benefits from China’s willingness to subsidize US borrowing … and the purchase of China’s goods.
Call me skeptical.
For one, China cannot subsidize its exports through a dollar peg without also importing US monetary policy — and it isn’t clear if that is good for China or the world. For example, China didn’t need loose monetary policy at the height of its own boom in late 2007. Yet that is what it got when the subprime crisis led the Fed to cut US rates. Nor will the effects of a monetary policy that is wrong for China necessarily be confined to China. Back in 2007, the loose monetary policy China imported from the US ended up reverberating globally – as the boom fueled by negative real rates in China (and other countries pegged to the dollar) contributed to the run up in commodity prices.
And then there are thethe geopolitical implications of US reliance on China’s government for subsidized financing. China already has close to a trillion dollars of Treasury bonds. It isn’t unreasonable to think that if it bought another trillion it might think it should get a bit of influence over US policy.
Moreover, America’s basic problem is that it consumed too much and borrowed too much over the past eight years. That was unsustainable. Consumption was too high relative to US income, and household savings were too low. We are all now paying a high price for imbalances– internal as well as external — that built during this period.
Yes, the biggest current risk is that it that consumption will fall too far to fast and no one will get access to credit. Gradual adjustment is good; sharp, sudden adjustments are not.
But that doesn’t mean that the US should want China to buy its bonds rather than its goods.
No country really has a comparative advantage “as consumers.” No one gets to trade their consumption for others’ production for ever, even if it sometimes seemed that way back when many emerging market governments were willing to trade their goods for US government bonds on terms favorable to US consumers and borrowers. The US didn’t have a comparative advantage at consumption so much as a comparative advantage at selling dollar debt to emerging market central banks who were trying to hold their currencies down.
Even now, the US isn’t in such dire need for financing that it has no option but to encourage China to hold its exchange rate down and in the process guarantee a captive Chinese market for US Treasury issuance.
The US Treasury can sell ten year debt in the market for less than 3%. That is a bit higher than a few years ago, but it is still a very low rate. So far demand for bonds has grown commensurately with bond issuance. By contrast, global demand for goods is shrinking.
China cannot stop buying more of the world’s bonds (Mankiw’s widely shared fear) unless it starts buying more of the world’s goods. And a world where global demand for US exports allows the US to generate needed jobs without running sustained fiscal deficits is very much in the United States long-run interest.
I would hope that China also would want a world where less of China’s savings is invested in the US. There are already signs that China’s leadership isn’t totally comfortable with its growing financial exposure to the US. And it isn’t clear that China’s public accepts that China’s government will take losses – at least in RMB terms – on all the money it channeled into the US, even though that is a logical byproduct of its policy of holding the RMB down to subsidize its exports.
Should China get credit for letting its currency appreciate 20% against the dollar?
The right answer likely depends in part on what the dollar is doing against other currencies. The 20% appreciation from mid 05 to mid 2008 came after the dollar already had depreciated heavily against a host of currencies. It was never enough to push the RMB back up against say the euro. Moreover, during the period when the RMB was appreciating most rapidly against the dollar, the dollar was still depreciating against a host of currencies: the RMB never moved much against a basket of the currencies of China’s trade partners then. The RMB only started to appreciate in nominal terms against such a basket when the dollar started to appreciate last fall.
The strongest argument against focusing on China’s currency right now is that the dollar’s appreciation at a time when the RMB has been tightly pegged to the dollar has finally generated a significant real appreciation. The RMB is still only a bit above its 2000 level in real terms, despite a huge increase in China’s productivity and a big increase in China’s current account surplus. That suggests the RMB remains under its long-term equilibrium value (more on this later). But the combination of a rising dollar-RMB and China’s own slowdown has led to a dramatic increase in capital outflows from China.
Some of these “hot” outflows are just the reversal of past “hot” inflows. But if China enters into a prolonged slump that leads to sustained capital outflows of around 10% of China’s GDP, China wouldn’t need to intervene in the currency market to offset a 10% of GDP current account surplus. And that would be evidence that the RMB isn’t being held below its current equilibrium level.
Large sustained capital outflows from China though do not strike as a likely outcome — in large part because it doesn’t strike me as an outcome that is neither in China’s interest (sustained capital outflows of this scale would be a vote of no confidence in China) or in the interest of China’s trading partners (as it implies structural RMB weakness). But at this stage it also cannot be entirely ruled out. The entire world economy is in flux.
There consequently is an argument for giving China a bit of time to adjust to the recent real appreciation of the RMB before pressing for more appreciation against the dollar.
But it doesn’t mean that the US shouldn’t be talking to China about whether China’s peg to the dollar creates the basis for a stable global monetary architecture …
Originally published at the CFR blog and reproduced here with the author’s permission.