I’ve been trying to wrap my head around the arguments about China’s currency control. Before the financial crisis got going, it was fairly easy to understand. China controlled their currency by investing in U.S. Treasury Bonds, which had the effect of keeping U.S. interest rates low. People in the U.S. borrowed money at low rates and spent it in China, encouraging Chinese exports and discouraging U.S. exports. China siphoned off a good chunk of the money through currency controls and sent it back to the U.S. It was a virtuous cycle, except that China kept accumulating bonds.
Back then there were mutterings about the cycle, but nobody really wanted to break it. Things are different now. Interest rates in the U.S. are low, really low. The U.S. no longer needs that Chinese investment to keep interest rates down. Now people are focusing more on the part about exports and imports. As long as China controls their currency, it will be hard for the U.S. to sell into China. Of course, it would be hard anyhow, as the Chinese government controls the Chinese market in many different ways. But making it possible to have competitive prices seems like a necessary first step.
The Chinese government’s controls on currency also have the effect of making their population poorer than they would otherwise be. The money that Chinese workers earn on the world market is not available to them to spend on imports. The government can get away with this because the standard of living is still rising in China, even if it is not rising as fast as it otherwise would. There is a second effect keeping Chinese people from spending on imports, which is that China does not have the social programs that European countries and to a lesser degree the U.S. has. That means that Chinese people save money when they can, because they can not count on getting support later when they need it.
Currency controls are a restraint on free trade, but they are also standard practice for developing countries. It makes sense to use currency controls to encourage people to invest locally and build up local production capabilities. But China is the second largest economy in the world; do they still count as a developing country?
If China lets their currency rise, their exports will inevitably fall. China would risk falling into a local recession. They could use their currency reserves to cushion the bad effects on people, but it would still tend to reduce local manufacturing capabilities. The Chinese government doesn’t want that. The potential gain for China is more abstract: by letting their currency rise, they help the overall global economy, which in turn, eventually, helps China. I don’t know if the Chinese government is prepared to take that sort of short-term risk for long-term gain.
On the U.S. side, the controlled level of the Chinese currency is a trade barrier. This hurts the U.S. in the long term, as it increasingly loses manufacturing capability as people pay artificially low prices to buy goods from China. The U.S. could address this by imposing trade barriers, but that would carry a different long-term cost: U.S. manufacturing capability, protected from direct competition, would become increasingly uncompetitive. The U.S. doesn’t have any good options that I can see.
So it seems to me that the discussions about Chinese currency become pointless. The U.S. has no leverage, and China knows that. China has no incentive to let their currency rise, so they won’t do it. I can see only one way out of this: the U.S. could balance the federal budget and stop selling long-term bonds. That would give China no way to control their currency relative to the dollar, and the currencies would start to move to a more sensible valuation. Unfortunately, U.S. political paralysis makes it impossible to either raise taxes or cut benefits, so this scenario seems unlikely.
Well, there is another way that things could change: the Chinese political system could change. A more democratic government in China would be more responsive to the desires of the Chinese population, and would therefore be less inclined to keep them in relative poverty to keep the export machinery humming. But that scenario also seems quite unlikely.
So things will most likely continue as they have been, to the detriment of people in both the U.S. and China. Unfortunate, but so it goes.
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