Sunday, 31 July 2011

China, US and the Currency Debate

The US public debt issue directly impacts China as the largest purchaser of US treasuries, but China is very close to balancing its interests and cutting its losses when it comes to the dollar. Having accumulated $3.2 trillion in foreign reserves after the Asian financial turmoil of the late 1990s, China has tried to protect itself from external shocks. Given that 40% of its trade is with US, EU, and Japan, all countries that suffered seriously in the global crisis of 2008-2011, China has been trying to become more 'multilateral' in financial and commercial relations, especially given US pressures about the undervalued currency - yuan - which translates into unfair trade practices.

In the past few years, especially in 2010, there have been repeated calls in the mass media, including one by popular economist Paul Krugman in a NYT article entitled “China, Japan, America,” to pressure the Chinese government to stop manipulating its currency, thereby undercutting the economies and balance of power of the developed countries with which it does business.

China is currently holding a reported $2.5 trillion in foreign reserves, of which about $1 trillion is US. Krugman and others like-minded commentators who have called for China to stop manipulating its currency leave the impression that the US, EU, Japan and other countries are not playing politics with their currencies like China, but permit the “invisible hand” to do its magic! In essence, the critics want China as a creditor nation to offer a discount for US bonds through overvalued yuan that would ease the burden on the dollar as a reserve currency.

This “populist” game that certain academics, journalists and politicians are playing very opportunistically is designed to apportion blame to external forces for the domestic economic problems in advanced capitalist countries, especially the US. Krugman is an intelligent economist and he knows that governments for centuries since the Roman Empire have manipulated currencies, just as he knows the US has engaged in this practice. Chinese currency manipulation is a complex political issue with serious multifaceted consequences if Washington upsets the delicate inter-dependency it has with Beijing. Krugman and like-minded individuals have further complained about Chinese subsidies.

Again populist critics know that the US, EU, Japan, Korea, Taiwan also provide subsidies in varying forms to strengthen certain domestic sectors or specific industries for the “good of the national economy.” All of this noise about China has been around for many years. It assumed momentum after a January 2007 report to Congress warned that “China’s Trade with the US and the World” posed threats to US, EU & Japan national industries and employment.
The US, EU and Japan have been concerned for many years about intellectual property rights violations and dumping by China. Beijing has deliberately kept its currency low and it is guilty of intellectual property rights violations and dumping; all issues that the World Trade Organization can help resolve with China as a member. However, it seems that journalists, consultants, and even academics are falling into the politicians’ perfidious mold of writing/saying what people want to hear, just so that they can be accepted by the public that responds to cryptic or overt nationalist rhetoric. 
The key question for the US economy is whether the solution rests a tariff war of some sort limited or extended. Reducing this issue into populist protectionist rhetoric to appease the public, only helps the few companies crying out for government help and does nothing to address structural problems in the US. The “economic nationalists”–at least those like Krugman currently playing the card for popular consumption–know that the US has an inter-dependent relationship with China, that the currency issue has many facets beyond economic, and that abrupt and direct pressure would hurt the US much more than China.

Besides, the US has imposed “select tariffs” on those Chinese products, including steel, copper, tires, and automotive parts, that the Commerce Department deems part of a “dumping campaign.” Moreover, the US and EU have intervened to prevent China from buying bonds from EU members and associate members beyond a certain amount. In short, the US and EU do not want China to create a “dependency” relationship with countries traditionally under the Western sphere of influence. The solution for the US and EU is to get their own public finances and economy in order, starting with a progressive fiscal policy and restructuring the economy on a jobs-growth basis as the IMF and ILO recommended during Olso meeting a few days ago. China is hardly responsible for the fact that the US and EU are over-consuming and under-producing to the detriment of their own socio-economic and political harmony.

Like the Latin-speaking half of the Roman Empire after the death of Marcus Aurelius, the US, the EU is right behind it, has chosen the road to wealth concentration in the hands of a small percentage, a runway culture of wasteful spending and over-consumption, and refusal to undertake systemic changes to alter the current course that will yield cyclical crises down the road. By contrast, China with a Communist regime–such as it is practicing capitalist economics–has opted for productivity oriented route and very slowly it is allowing consumption to filter down to the masses.

History will judge in a few decades if the Chinese or the US-EU models of development will best serve their respective populations. The Chinese model–detrimental as it is to hundreds of millions of cheap laborers working under unsafe and unhealthy conditions–is focused on exported-oriented growth strategy with low domestic consumption. The US-EU model rests on perpetual debt-by-growth strategy, using the reserve currencies and political power to maintain global market advantages, weakening the welfare state and focusing on strengthening finance capital while hoping that will somehow filter down to benefit the middle class needed to maintain the existing social order. 
The global economic crisis of 2008-2011 awakened China to the reality of how its economy could be seriously undermined because of how Western governments manage their own economies and public finances, using the state as a vehicle to redistribute income from the bottom up, thus undermining the mass consumer base. If China decides to stimulate internal demand - raising incomes - thus relying less on external demand for its products, it would also have to rethink the purchase of foreign bonds, especially US. 
In short, China's domestic economic policy will have an impact on the value of the dollar and on the US economy. The question is whether it is in China's interest in the next tow to five to years to make any sudden moves with regard to the US debt, or whether it should opt for a smooth transition as it plans to move into the number one economic position in the world, a position which entails massive responsibility toward the US, EU and Japan.

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