Paul Krugman: Taking on China

Paul Krugman says it's time to take a stand against China's currency policy:

Taking on China, by Paul Krugman, Commentary, NY Times: Tensions are rising over Chinese economic policy, and rightly so: China’s policy of keeping its currency, the renminbi, undervalued has become a significant drag on global economic recovery. Something must be done. ...

Today, China is adding more than $30 billion a month to its $2.4 trillion hoard of reserves. ... This is the most distortionary exchange rate policy any major nation has ever followed.

And it’s a policy that seriously damages the rest of the world. Most of the world’s large economies are stuck in a liquidity trap — deeply depressed, but unable to generate a recovery by cutting interest rates because the relevant rates are already near zero. China, by engineering an unwarranted trade surplus, is in effect imposing an anti-stimulus on these economies, which they can’t offset.

So how should we respond? First of all, the U.S. Treasury Department must stop fudging and obfuscating.

Twice a year, by law, Treasury must issue a report identifying nations that “manipulate the rate of exchange between their currency and the United States dollar...” ... Treasury has been ... unwilling to take action on the renminbi... Instead, it has spent the past six or seven years pretending not to see the obvious.

Will the next report, due April 15, continue this tradition? Stay tuned.

If Treasury does find Chinese currency manipulation,... we have to get past a common misunderstanding ... that the Chinese have us over a barrel because we don’t dare provoke China into dumping its dollar assets.

What you have to ask is, What would happen if China tried to sell a large share of its U.S. assets? Would interest rates soar? Short-term U.S. interest rates wouldn’t change: they’re being kept near zero by the Fed... Long-term rates might rise slightly, but ... the Fed could offset any interest-rate impact of a Chinese pullback by expanding its own purchases of long-term bonds.

It’s true that if China dumped its U.S. assets the value of the dollar would fall against other major currencies... But that would be a good thing ... since it would make our goods more competitive and reduce our trade deficit. On the other hand, it would be a bad thing for China, which would suffer large losses on its dollar holdings. In short, right now America has China over a barrel, not the other way around.

So we have no reason to fear China. But what should we do?

Some still argue that we must reason gently with China, not confront it. But we’ve been reasoning with China for years ... and gotten nowhere: on Sunday Wen Jiabao, the Chinese prime minister, declared — absurdly — that his nation’s currency is not undervalued. ... And Mr. Wen accused other nations of doing what China actually does, seeking to weaken their currencies “just for the purposes of increasing their own exports.”

But if sweet reason won’t work, what’s the alternative? In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10 percent surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies. At this point, it’s hard to see China changing its policies unless faced with the threat of similar action — except that this time the surcharge would have to be much larger, say 25 percent.

I don’t propose this turn to policy hardball lightly. But Chinese currency policy is adding materially to the world’s economic problems at a time when those problems are already very severe. It’s time to take a stand.