China's currency manipulation used to be a problem, but isn't as much anymore
If it's election season, then it must be time to bash China for currency manipulation. Right on cue, Mitt Romney has promised to label our second-largest trade partner a currency manipulator from "day one" -- which Alan Beattie of the Financial Times points out wouldn't actually do anything -- and then levy countervailing tariffs on their goods. This would be a defensible policy -- if it were 2007. But guess what. It's not 2007 anymore.
Currency manipulation itself is a simple game. It just means printing money to buy foreign currency, which suppresses the value of your own. A weaker currency not only means cheaper and more competitive exports, but also keeps prices from falling too much -- it's monetary easing.
But not all currency manipulators are created equal. As Josh Barro of Bloomberg View points out, Switzerland is actually a bigger manipulator now than China, but Romney isn't exactly rushing to start a trade war with the Swiss. Why not? Well, some countries push down their currencies to push up their trade surpluses, and others push down their currencies to try to push down capital inflows. It can be hard to distinguish one from the other, but it's not when it comes to China. They restrict capital flows and still manipulate their currency down. There's a word for this. That word is mercantilism.
But China's age of mercantilism is over, mostly. The renminbi has appreciated quite a bit in real terms the past few years, as Paul Krugman, who wanted to get tough with China back in 2009, now points out. Still, just because currency manipulation isn't the issue it was before doesn't mean that it won't be again in the future. I talked with Harvard professor Dani Rodrik, author of the highly recommended The Globalization Paradox, about the good, the bad, and the mercantilist of currency manipulation -- and how the rules of the global economy need to change.
MO: How long has Chinese currency manipulation been a concern?
DR: It became a big issue in the early 2000s. That's when its current account surplus really widened -- it's a fairly recent phenomenon. It began after China joined the WTO. I've made the argument that by default or design, an undervalued currency became China's de facto industrial policy, because it couldn't pursue other industrial policies, like export subsidies, due to WTO membership. The current account actually peaked in 2007, which is just before the crisis hit, and that's really when the Chinese growth rate also peaked. And that has been coming down since.
How big an issue do you think China's currency manipulation was, and how big a problem is it now?
I think it was a big issue. It had the potential to remain a huge issue if it hadn't come down somewhat drastically in the last couple of years. It's obviously becoming less salient an issue since then. But I'm not sure whether it has gone away forever, or whether this is just a temporary apparition. I think there are fundamental strains in China's economy, and an important reason that the current account has come down is that the growth rate has come down. If China wants to go back to growth rates of 9-10 percent, it's going to be very difficult to do so without widening the export surplus at the same time. They haven't managed to bring the current account down by undertaking this much desired and much talked adjustment towards domestic demand. They brought it down by bringing down their growth rate.
Of course, bringing down their growth rate has all kinds of implications for China that I'm not sure they're ready to handle or know how to handle. It could mean increasing factory closures, unemployment, and social strife. This is the kind of thing the Chinese leadership really hates. So there are question marks about whether there will be pressures for China to find ways to reactivate their economy by re-engineering a trade surplus through currency manipulation or otherwise. Even though it currently seems like less of an issue, I think that there is a medium-term issue there that we'll need to confront.
But right now you don't think it merits much attention now?
Well, you know, with a 2 percent current account surplus now, I think it seems a little bit odd to give China a hard time.
You've supported countries managing their exchange rates to mange their economies, particularly developing nations -- where would you draw the line between countries like Poland, Switzerland or Israel that devalued their currencies quite significantly during the crisis, and China of a couple years ago. When does it become unacceptable?
I am convinced if we don't leave some room for countries to manage their macroeconomic cycles that one way or another the pressures for them to do so will show up by breaking the formal or informal rules of the game. You cannot at the same time expect countries to have free financial flows of capital, to have very low levels of trade protection, and expect them to follow perfect currency floats -- to not care about the level of exchange rate. I think that's economically and politically a non-starter. I think the problem we're seeing with countries essentially having to intervene in currency markets is they have very few instruments left, and this is the instrument they see that's the simplest to manipulate -- because they don't have much room with respect to WTO trade rules, and they don't really know what to do with respect to capital flows. And so the pressure shows up in what we call currency manipulation.
I just don't think it makes sense for us a system to assume we can ever reach a sustainable equilibrium where we constrain countries with respect to their ability to manage capital flows, their ability to manage their trade regime, and their ability to manage the exchange rate. It's just a recipe for returning to the gold standard rules, and setting up a big clash between those rules and what domestic politics will require.
So, is there a legitimate difference between manipulating the exchange rate to manage the macroeconomy during a crisis versus doing so as part of a development strategy? Would you say what Switzerland's doing is okay and what China's doing is not, even though Switzerland has bigger foreign reserves than China does as a percent of GDP?
I find policies directed at affecting the volume and composition of capital flows the least objectionable. The more we allow countries to manage their capital accounts, to manage cross-border lending and borrowing, the less need there will be to manipulate their currency or trade regime. I would start from there. Much of this pressure is happening because countries feel hamstrung with respect to capital flows. This is clearly the issue for Brazil and Switzerland, though it's a bit less of an issue for China. For instance, Switzerland is a financially open economy that's a haven for the rest of the world. The last thing they want is to be seen managing capital inflows. Instead, they're forced to intervene heavily to prevent the appreciation of the Swiss franc. What is damaging, and what is something we can legitimately be concerned about, is when countries are manipulating their exchange rate with the express purpose of generating a current account surplus. That comes very close to being a mercantilist policy. That has significant negative spillovers for other countries. After all, every surplus has to have a deficit somewhere else.
In my own preferred world, countries would feel much freer to manage and control financial flows across borders to take the pressure off temporary currency appreciation. Systemically important countries like China and large industrialized countries would face rules that prevent them from manipulating their currencies for mercantilist reasons. But at the same time, there would be slightly less discipline on their use of trade policies, so, if need be, they would be freer than they are now to provide temporary protection to industries that are suffering. The better answer for China going forward is to have a bit more room to maneuver on trade and industrial policy than to bail out their industries by manipulating their currency.
So, to sum up, under the regime we have now, you think it's alright to intervene in your currency to counteract capital flows, but not to try to engineer a bigger trade surplus?
Obviously that can be a murky thing to work out sometimes. Take Switzerland. They do have huge capital inflows, but they also have a sizable trade surplus, something like 12 percent of GDP.
Right, that's been more of a structural feature of their economy.
To bring it back to the U.S., what do you make of Fed critics who point at QE3 and say we're manipulating our currency?
I don't have much sympathy for that argument. It's perfectly legitimate for the U.S. to try to revive its own economy through monetary expansion. If countries like Brazil feel spillover in the form of capital inflows, that in turn appreciate their exchange rate and make it harder to manage their economy, they ought to respond by preventing this hot flow from coming in. After all, there is a commonality of interest here. The U.S. wants to keep the money in -- that's the whole point of issuing the liquidity -- so it's not like the U.S. wants the money to go to Brazil. The same with Brazil. They don't want the money coming in. So everybody wants to keep the dollars in the U.S. There is no conflict of interest here. The appropriate solution is for countries like Brazil that don't want the dollars to come into their economy to take a harder line against capital inflows.
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Matthew O'Brien is a former senior associate editor at The Atlantic.