Paul Krugman suggests that the US should impose a 25 per cent surcharge on imports from China to protect American exports from an undervalued renminbi. The effect of the alleged undervaluation of the Chinese exports is to provide US consumers with a bonus – to subsidize their consumption. Maintaining a stable RMB also preserves for China the value of the substantial borrowings the US has made from China. The bellyaching by the US about China is a threat by the US to repudiate part of its Chinese debt. If China dumps or refuses to continue to fund US debt then the US dollar will fall and the residual value of that debt will take a hit. Calls by the US for China to revalue its exchange rate are effectively calls for China to stop lending to the US.
The US needs to produce and save more. It needs to stop living beyond its means. It must rebuild an economy based on producing internationally-valued output rather than operating as a giant casino with far too many spiv schemes for achieving instant wealth via a bloated finance sector – an economy should not be spending 8 per cent of its productive resources on ‘innovative’ finance. As many have pointed out the US financial system needs to be regulated.
In the days when macroeconomic theory seemed simpler than in its current poses the effect of maintaining fixed exchange rates was seen as equivalent to flexible exchange rates in the long-run because accumulating foreign reserves would drive up prices in the economy with surpluses and reduce them in countries with deficits thereby automatically eliminating trade deficits – the price-specie-flow mechanism. This isn’t happening presumably because of the Chinese lending – or is my accounting here in error? This is a question to macroeconomics experts. The US gains cheap consumption goods from China which it funds, in part, by loans from China which it then threatens to at least in part repudiate.
US commentators, including those on the left, have a nerve criticizing Chinese policies in many areas. On climate change it is difficult for the US to criticize China when the US itself, a wealthy country, has done so little and China is already doing so much.
If you can’t solve your own problems, make sure you blame them on someone else — even if it makes the situation far worse.
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It’s not just the huge amount spent on trying to get rich by fiddling numbers (including the massive government subsidies) — it’s the huge amount wasted on their military machine. It’s like the old Soviet Union where all their money was spent on paranoia and non-productive things like thousands and thousands of nukes.
Another new posting with valid points, I’ve been a lurker here for a short time but wish to become more engaged soon.
Harry, if you want the US to consume less and produce more than one key price is going to change and that is the US dollar renminbi exchang rate. Krugman is right. The Chinese are not allowing a key equilibrating mechanism to run its course. This is not in anyone’s interest.
Prices do matter in macroeconomics.
As to why the Chinese build up of forex isn’t inflationary, as you’d expect, it’s a good question. But China is not a normal economy. They can stop banks from lending all this putative excess liquidity by regulation and fiat.
Uncle Milton, So you are saying that the price-specie-flow mechanism doesn’t operate (so a fixed exchange rate system doesn’t lead to inflation in the surplus country) because government controls on lending limit the money supply expansion effects of a build-up in foreign reserves. That doesn’t sound right – currently real interest rates are negative in China and there is a massive credit expansion. Indeed there are widespread fears of a bubble.
The question I asked in the post was whether Chinese purchases of US Treasury bills partly nullify the effects of an expansion due to reserve increases in the Chinese monetary base? I assume China pays for these T bills with US reserves.
The RMB has appreciated by 25% over recent years. Krugman et al are arguing for up to a further 40% increase. How would you like you savings devalued by over 50% in toto. That’s what Krugman is asking of the Chinese. Thanks for the loans fellas but we will pay you back in dollars that are worth less than half of what they were worth when we borrowed from you. Of course the Chinese are upset.
Harry, if the Chinese central bank is merely exchanging $US cash for T bills I don’t see how this can affect the total assets in their balance sheet and hence the monetary base, but I could be wrong about that.
On the currency, well of course the Chinese are going to be upset, but this is the risk you take when you invest in foreign currency denominated assets, and if you are grossly over weight in those assets then you are taking a very big risk.
Krugman is right. The US has got them by the short and curliest. It’s a variation on the old story. If the bank lends you a million and you can’t pay it back then you’ve got a problem. If it’s a billion then the bank has a problem.
The Chinese might also come to reaiise that it is in their interests that the US economy recovers as quickly as possible and that can only happen if the $US devalues.
And they should also remember that the purpose of exporting is not to build forex reserves but to enable you to pay for imports. If the Chinese revalue the renminbi they will be able Tobit a lot of imports cheaply and thereby do a lot to improve the standard of living of the Chinese people. What’s wrong with that?
“Krugman is right. The US has got them by the short and curliest.”
I don’t think that’s correct — I don’t see why they can’t slowly get rid of it as appears to be beggining to happen already
http://www.chinadaily.com.cn/bizchina/2010-02/22/content_9484093.htm
and simply plonk it into other assets.
Hmm, so we do a Soros and go short on US Treasury bonds…
Sir Henry, These things can take a long time to unravel but your intuition is sound.