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Saturday, June 10, 2006

Robert Mundell: Don't Pressure China Into a Large Revaluation

Robert Mundell says a large revaluation of the yuan in a short time period is not the best way to address the trade imbalance problem the U.S. has with China:

Don't push China to revalue currency, Canadian Nobel economist Mundell says, by Steve Mertl, CBC: Fear of China's growing economic power is pushing its competitors in potentially dangerous directions, says economist Robert Mundell, the Canadian-born Nobel Prize winner... U.S. politicians and some business leaders accuse China of keeping its currency ... at an artificially low fixed exchange rate with the U.S. dollar to make its exports more attractive.

Mundell ... has been critical of U.S. government and International Monetary Fund pressure on China to revalue its currency ... or let it float. "I don't think China will accept it," said Mundell. "It's ... not a good policy for the United States or the IMF to push because it would do countless damage to the poorer parts of the Chinese economy." ...

China ... still has 80 million people living on less than $1,000 US a year. Boosting the yuan by the 40 to 50 per cent that some have demanded would make their products instantly uncompetitive, Mundell warned. "Appreciation would be devastating to those people," he said.

Mundell noted the Japanese economy ground to a halt for most of the 1990s and its banking system collapsed after Japan agreed to boost the yen. Removing exchange controls by allowing China's currency to float would be equally damaging as Chinese demand for dollars exploded and the yuan tanked...

There is a legitimate concern with China's balance of payments as it accumulates huge foreign exchange reserves, he said. "That's a problem that the United States and other countries have a right to complain about...," said Mundell. But the solution lies in getting China to invest more abroad and to open its domestic market wider so consumers can buy more imported goods...

China did respond to pressure last July by boosting its currency by two per cent and increasing its value in tiny monthly increments since then. "I think they still accept my view that a big appreciation would be very harmful to them," he said, but noted there have been mixed messages from the government and China's central bank...

[A] U.S. perception of China as an economic threat should not be discounted, Mundell warned. "I think it would be a mistake to discount the threat of a clash between the United States and China," he said. "Whenever one power starts to challenge the power of a super economy or the existing power structure, that often leads to world war. "We did that in 1914 and we did that in the 1930s with Japan, and the 1940s again with Germany."

There are distributional issues within the U.S. to consider also. Recall what Paul Krugman had to say about this just after China revalued by 2%:

China Unpegs Itself, by Paul Krugman: One way to grasp how weird this policy is would be to think about what a comparable policy would look like in the United States, scaled up to match the size of our economy. It's as if last year the U.S. government invested $1 trillion of taxpayers' money in low-interest Japanese bonds, and this year looks set to invest an additional $1.5 trillion the same way.

Some economists think there is a deep rationale for this seemingly perverse policy. I think it's something the Chinese government stumbled into as it tried to protect itself from the 1997-1998 crisis, and it is reluctant to change because ... China's leaders don't want to mess with success.

But ... China's dollar purchases are ... feeding a trade surplus that is creating a growing political backlash in America and Europe. ... The question is what happens to us if the Chinese finally decide to stop acting so strangely.

An end to China's dollar-buying spree would lead to a sharp rise in the value of the yuan. It would probably also lead to a sharp fall in the value of the dollar relative to other major currencies, like the yen and the euro, which the Chinese haven't been buying on the same scale. This would help U.S. manufacturers by raising their competitors' costs. But if the Chinese stopped buying all those U.S. bonds, interest rates would rise. This would be bad news for housing - maybe very bad news...

In the long run, the economic effects of an end to China's dollar buying would even out. America would have more industrial workers and fewer real estate agents, more jobs in Michigan and fewer in Florida, leaving the overall level of employment pretty much unaffected. But as John Maynard Keynes pointed out, in the long run we are all dead.

In the short run, some people would win, but others would lose. And I suspect that the losers would greatly outnumber the winners.

And what about the strategic effects? Right now America is a superpower living on credit - something I don't think has happened since Philip II ruled Spain. What will happen to our stature if and when China takes away our credit card? ... On the first day of the new policy, the yuan rose only 2 percent, not enough to make any noticeable difference. But one of these days Chinese dollar purchases will trail off, and we'll find ourselves living in interesting times.

Update:

US to boost high-tech trade with China, chinadaily.com.cn/Agencies: The Bush administration is to revise laws to facilitate export of hi-tech equipment to China under a new policy designed to narrow its ring trade gap with the world's fastest growing economy.

The United States said it would revise laws to facilitate export of sensitive high technology equipment to China under a new policy designed to prevent such products from being used for military purposes. The new policy will spare the need for US exporters in such sectors as semiconductor equipment and electronics to apply for licenses for sales to Chinese companies...

The new policy, McCormick emphasized, would prevent exports of US technologies for incorporation into the weapons systems in China...

    Posted by on Saturday, June 10, 2006 at 01:32 AM in China, Economics, International Finance, Policy | Permalink  TrackBack (0)  Comments (26)

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