This is the next installment in a catching-up-with-the-week's-events series, as advertised here. Today's topic: US-China relations, economic imbalances, and the value of the Chinese RMB.
In his NYT column yesterday, Paul Krugman discussed the Chinese government's refusal to let the RMB rise against the dollar, which (since the dollar is falling versus most other currencies) means that the RMB is rapidly sinking in value against the Euro and yen, even as China runs up huge trade surpluses. This, Krugman said, was a "predatory" policy that should and would provoke retaliation from the rest of the world.
My reaction on reading the column was, Matte mashita!, roughly "I've been waiting for this!", the phrase that audiences at Japanese kabuki performances may yell at the appearance of a favored character or famous line. For nearly a year, I have been watching the economic press in anticipation of just this kind of article.
It was about a year ago, in the devastation of China's manufacturing-export business that followed the world economic collapse, that I spoke with the financial-markets expert Michael Pettis, at Guanghua School of Business in Beijing. I wrote about his views (and others') in this article last spring in the Atlantic.
The heart of Pettis's argument was that China's economy in this past year was like America's in the early 1930s. Each had been the workshop of the world in the preceding decade; each had piled up huge trade surpluses and financial reserves; and -- the underappreciated part -- each suffered big job losses when its foreign customers could no longer buy its excess production. Having had more than "its fair share" of the world's manufacturing jobs in the 1920s, the US had more of them to lose in the 1930s. So too with China as demand fell around the world last year. Relatively more of China's people had depended on foreign customers for their jobs, thus relatively more of them were at risk than in Europe or the US. And indeed, tens of millions of Chinese factory jobs disappeared last year, especially in the southern part of the country.
The crucial part of Pettis' analysis was the next step: whether China would respond to this loss the way the U.S. had in the 1930s. Back then, desperate to protect American factory jobs, the U.S. Congress passed the Smoot-Hawley tariff, with levies on thousands of product categories. In itself, that tariff was not the cause of the world Depression (contrary to the implications of "Smoot Hawley" in the standard political speech or op-ed column). But as other countries retaliated, the cascading failure of demand intensified the hard times worldwide.
To bring this back to Krugman and China: Pettis concluded that the natural result of last year's economic slowdown would be the shrinkage of China's export economy and global trade surplus. Anything else would delay the "rebalancing" of economies that was necessary worldwide. If China tried too hard to prevent this, then that step would be the modern Smoot Hawley equivalent. As I put it in the article:
"The real damage of Smoot-Hawley, [Pettis] says, was less economic than political. Other countries understood that the United States was trying to protect its trade surplus and therefore its workforce. They didn't like it as a political matter, and they struck back.
"If that were to happen again... the real counterpart to Smoot-Hawley would be Chinese protectionism--or rather, any effort by China to defend its huge trade surpluses, as the U.S. once did. China's government is unlikely to rely on outright Smoot-Hawley-style tariffs. Instead it could increase subsidies to exporters; it could try to push the RMB's value back down, after three years of letting the currency rise; it could encourage manufacturers to restrain wages; it could impose indirect barriers to imports, as with its recent pressure on China's airlines to cancel outstanding orders for Boeing and Airbus airplanes. By early this year, China's government was in fact doing every one of these things."
That is the context for Krugman's article, in my view. Political leaders around the world talk about the need to "rebalance" their economies; this means more saving and less overconsumption in the United States; but it also means less under-consumption in China, in the sense of relying less on foreigners as customers. As long as the Chinese government holds the line on the RMB, it is doing its best to resist and thwart that balancing process. As I argued in another article, the value of the RMB is not at all the main reason for China's manufacturing success or the shift of world jobs to China. But the refusal to let that value change will become a major impediment to the global economic adjustment that China's leaders (with all others) say is necessary.
The bottom line of Krugman's column is: if China's government doesn't change this policy, it is inviting trouble for itself and everyone else. To me this seems obviously right.
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