Monday 9 February 2009
Peg the yuan to US dollar to end the war of words
A couple of weeks ago, new United States Treasury Secretary Timothy Geithner ignited a firestorm of comments and criticism when he accused China of manipulating its currency, effectively saying that Beijing keeps the yuan artificially undervalued to steal an unfair advantage for its exports in world markets.
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Peg the yuan to US dollar to end the war of words
Tom Holland
6 February 2009
A couple of weeks ago, new United States Treasury Secretary Timothy Geithner ignited a firestorm of comments and criticism when he accused China of manipulating its currency, effectively saying that Beijing keeps the yuan artificially undervalued to steal an unfair advantage for its exports in world markets.
His comments were received rapturously by many US politicians, economists, manufacturers and labour activists, who believe passionately that a big jump in the value of the yuan against the US dollar is essential to correct the massive trade imbalance between China and America and to allow the US economy to claw its way out of recession.
Happily for grown-up debate, not everyone who disagrees is as shrill as the officials who issued Beijing’s outraged rebuttal of Mr. Geithner’s position.
In a finely timed new paper, long-time currency economics iconoclast Stanford University professor Ronald MacKinnon and co-author Gunther Schnabl from Germany’s Leipzig University artfully demolish a few common myths about the yuan.
Far from pursuing yuan appreciation, they argue persuasively that Washington should collaborate with Beijing in pegging the yuan’s exchange rate to the US dollar. This new Bretton Woods-style agreement, they maintain, would permit an orderly unwinding of global imbalances and establish a stable base from which the world economy could get back on its feet.
The first myth they knock down is that yuan appreciation by itself could reduce China’s bilateral trade surplus with the US.
If you think about it, this is obvious. After all, as the charts below illustrate, between the beginning of 2005 and the end of last year, the yuan strengthened 21 per cent against the US dollar. And far from shrinking, China’s bilateral trade surplus ballooned, roughly doubling in value.
Similarly, the fivefold appreciation of the Japanese yen against the dollar between the early 1970s and the mid-1990s was accompanied by a rise in Japan’s trade surplus from negligible levels to a peak of 5 per cent of gross domestic product in the late 1980s.
Clearly, whatever Washington’s China-bashers like to say, exchange rates do not determine trade imbalances.
The second myth that Professors McKinnon and Schnabl shoot down is that Beijing needs to appreciate the yuan in order to control inflationary pressure.
This argument was widely repeated last year as price rises mounted. But far from quelling inflation, the professors argue that currency appreciation was a principal cause of price rises.
Sure the yuan was a one-way bet, investors poured money into China, overwhelming the ability of the central bank with its underdeveloped market levers to control the domestic monetary system. As a result, prices shot up.
Finally, they rubbish the idea that the yuan, if allowed to float freely, would naturally find an equilibrium exchange rate.
China, the professors point out, is an immature creditor which does not lend internationally in its own currency. That makes Chinese banks extremely reluctant to recycle capital abroad lest they suffer a currency mismatch between their foreign assets and domestic liabilities. As a result, a free float would lead to “an indefinite upward spiral” in the yuan against the dollar.
The solution, argue Professors McKinnon and Schnabl, is for China to peg the yuan to the dollar. That would both allow private mainland capital to flow overseas where it would ease credit constraints, and provide a solid monetary anchor against which Beijing could expand its fiscal stimulus spending to boost domestic demand.
The end result would be an orderly unwinding of the economic imbalances between China and the US, and a lot less bad-tempered invective.
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