BUSINESS CLASS: The China syndrome

Our travels this week take us from China to the US and back to China again, as we follow the international tit-for-tat over whether the cheap renminbi is the root of all economic evil.

China is back on the dart board of international business commentary this week, under fire from economists, politicians, The New York Times and various other global financial types, over Beijing's steadfast refusal to let the national currency, the renminbi, appreciate against the US dollar.

The problem, it is argued, is that an artificially cheap renminbi – aka the yuan – "increases Chinese exports at the expense of the rest of the world’s economies".

Or, as Cornell University economist and former head of the IMF’s China branch Eswar S. Prasad put it last weekend: "Maintaining an undervalued exchange rate certainly benefits China, but at the expense of other countries that lose their relative competitiveness in foreign trade.

"It is encouraging that [China's central bank head] Governor Zhou [Xiaochuan] ...suggests that the move to a managed float of the renminbi will be resumed once the global recovery firms up," said Prasad. "It would be even more helpful if, given its economic strength and solid recovery prospects, China’s exchange rate policy could make a contribution to the global recovery rather than being frozen in place while other economies."

But as Premier Wen Jiabao made haste to assert, China won't be obliging said 'other economies' any time soon. Instead, reports the NYT, Premier Wen responded to the latest round of international nudges by accusing "unnamed competitors of trying to bail out their own slumping economies by hamstringing China.

"I understand some economies want to increase their exports," he said. "But what I don’t understand is the practice of depreciating one’s own currency and attempting to force other countries to appreciate their own currencies, just for the purpose of increasing their own exports."

Needless to say, this went down like the price of a Florida condo. It also had the effect of upgrading the problem from a matter of mild, long-term international concern to an imminent catastrophe of world economy-shattering proportions, not to mention a matter of American national pride, with the ghoulish spectre of trade sanctions even being evoked.

So is it as serious as all that?

NYT's Paul Krugman says yes. "By running an artificial current account surplus that is 1 per cent of the combined GDPs of liquidity-trap countries [by the way, that's "almost all advanced countries", according to Krugman], China is in effect imposing an anti-stimulus of that magnitude – which plausibly means 1.5 per cent of GDP. This is not a small issue."

And just in case you were unsure who the villain was in this scenario, Krugman can clear that up too. "The really outlandish actor here is China: never before in history has a nation followed this drastic a mercantilist policy. And for those who counsel patience... the acute damage from China’s currency policy is happening now, while the world is still in a liquidity trap. Getting China to rethink that policy years from now, when (one can hope) advanced economies have returned to more or less full employment, is worth very little. ...This has to stop."

And just in case you don't feel like taking Krugman's word for it, here is the Times editorial to back him up, and to issue a call-to-arms while they're at it: "The drumbeat of complaints in Washington about China’s manipulation of its currency — and the deafening silence pretty much everywhere else — might lead one to think that this is just an American problem. It isn’t. ...

"The world’s battered economy is certainly in no shape to keep absorbing China’s exports, subsidised through a cheap currency policy. The more countries that say this, the more likely Beijing will consider changing course — and the less likely this disagreement will escalate into a fight that no one can win."

And the Financial Times', Martin Wolf agrees, although he's putting Germany on the naughty step alongside China. (And he's calling them "Chermany". Clever.)

"'Chermany' spoke last week and the world listened. Was what it said coherent? No. Was what it said self-righteous? Very much so. Was what it said dangerous? Yes. Will wiser views still prevail? I doubt it.

"Behind all this is a fundamental divide," continues Wolf. "Surplus countries insist on continuing just as before. But they refuse to accept that their reliance on export surpluses must rebound upon themselves, once their customers go broke... If surplus countries fail to offset that shift, through expansion in aggregate demand, the world is inevitably caught in a 'beggar-my-neighbour' battle... [that] the surplus countries are most unlikely to win. A disruption of the eurozone would be very bad for German manufacturing. A US resort to protectionism would be very bad for China."

But The Economist's Free Exchange blogger Ryan Avent disagrees: "Krugman's proposed policy is wrong-headed and based on an incorrect assessment of potential benefits. But I also think ...that it probably wouldn't work; China doesn't want to be seen as a weakling to be pushed around by America. Even if it didn't retaliate, it might just depreciate its currency further to compensate for the effect of the import surcharges. And it might retaliate. It should be clear; this is neither the time nor the way to approach this issue."

The WSJ also takes issue with the Krugman line of argument. "The US is more wrong than China here," said the paper in an editorial this week. "A fixed exchange rate is ...not some nefarious economic practice rare in human affairs. ...By maintaining a fixed yuan-dollar rate, China has subcontracted much of its monetary discretion to the Fed in return for the benefits of exchange-rate stability. For more than a decade, this has served the world economy well, leading to an explosion of trade, cheaper goods for Americans that have raised US living standards, and new prosperity for tens of millions of Chinese.

Now, it continues, "the same US and European economists and columnists who peddled Keynesian stimulus as an economic cure-all ...tell us that their policies would be working better if only the yuan-dollar price were different. Because their own ideas have flopped, they now want to make the yuan a scapegoat and risk a trade war with China. Haven't they done enough harm already?"

Over at BusinessWeek, William Pesek is in two minds. While he agrees that China’s undervalued currency is making trade a "zero-sum game," he doesn't think America is the right country to deliver that message.

"China isn’t going to boost the yuan because US Treasury Secretary Timothy Geithner wants it. It’s not going to hobble its export juggernaut because Nobel Prize winner Paul Krugman wants it. The US, let’s face it, has zero moral high ground when it comes to the state of global imbalances.

"Things will be very different when the griping comes from places such as Thailand, Indonesia, Singapore or Vietnam. And that gets at the central question: Why isn’t the developing world speaking out? It certainly should be. Until it does, don’t expect big moves on the yuan."

Meanwhile, Time magazine's Curious Capitalist Michael Schuman isn't convinced that a stronger yuan is the panacea to America's economic problems that it's cracked up to be.

"In fact, a stronger yuan might actually be detrimental to the US economy in certain key ways," he says. "The reality Americans have to digest is that China manufacturers a tremendous share of the world's basic consumer products ... and that will likely continue to be true for the foreseeable future, whatever the value of the yuan. ...China also has competitive advantages beyond its currency, from excellent infrastructure to low wages, which will keep its factories humming even if the yuan strengthens. Therefore, all a more expensive yuan might achieve is making all of those Chinese goods at your local Wal-Mart more expensive – and that's not good for a US consumer already burdened by debt and job instability."

As for whether we in Australia should be worried about developments in and around China, BS's own Adam Carr says fahgettaboudit: "Short of a comet hitting the earth, or major policy blunders, prospects for the Australian economy are excellent – even in the unlikely event of a marked slowing in Chinese growth."