Will China's currency policy lead to a "full-fledged" economic crisis?:
China Goes to Nixon, by paul Krugman, Commentary, NY Times: With Hu Jintao, China’s president, currently visiting the United States, stories about growing Chinese economic might are everywhere. And those stories are entirely true: ...it’s growing fast, and given its sheer size it’s well on the way to matching America as an economic superpower.
What’s also true, however, is that China has stumbled into a monetary muddle that’s getting worse with each passing month. ... The root cause ... is its weak-currency policy, which is feeding an artificially large trade surplus. As I’ve emphasized in the past, this policy hurts the rest of the world, increasing unemployment in many other countries, America included.
But a policy can be bad for us without being good for China. ...Chinese currency policy is a lose-lose proposition, simultaneously depressing employment here and producing an overheated, inflation-prone economy in China itself.
One way to think about what’s happening is that inflation is the market’s way of undoing currency manipulation. ... China’s leaders are, however, trying to prevent this outcome, not just to protect exporters’ interest, but because inflation is even more unpopular in China than it is elsewhere. ...
But for whatever reason — the power of export interests, refusal to do anything that looks like giving in to U.S. demands or sheer inability to think clearly — they’re not willing to deal with the root cause and let their currency rise. Instead, they are trying to control inflation by raising interest rates and restricting credit.
This is destructive from a global point of view: with much of the world economy still depressed, the last thing we need is major players pursuing tight-money policies. More to the point from China’s perspective, however, is that it’s not working. Credit limits are proving hard to enforce and are being further undermined by inflows of hot money from abroad.
With efforts to cool the economy falling short, China has been trying to limit inflation with price controls — a policy that rarely works. In particular, it’s a policy that failed dismally the last time it was tried here, during the Nixon administration. (And, yes, this means that right now China is going to Nixon.)
So what’s left? Well, China has turned to the blame game, accusing the Federal Reserve (wrongly) of creating the problem by printing too much money. But ... blaming the Fed ... won’t change U.S. monetary policy, nor will it do anything to tame China’s inflation monster.
Could all of this ... turn into a full-fledged crisis? If I didn’t know my economic history, I’d find the idea implausible. After all, the solution to China’s monetary muddle is both simple and obvious: just let the currency rise, already.
But I do know my economic history, which means that I know how often governments refuse, sometimes for many years, to do the obviously right thing — and especially when currency values are concerned. Usually they try to keep their currencies artificially strong rather than artificially weak; but it can be a big mess either way.
So our newest economic superpower may indeed be on its way to some kind of economic crisis, with collateral damage to the world as a whole. Did we need this?