Tuesday, March 16, 2010

The Yuan Peg Controversy

In difficult times, trade disputes grow. Paul Krugman is "Taking on China", the title of a recent column in the New York Times (March 14). The reasons of this bellicose posturing? The yuan’s peg to the dollar:

« 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. The International Monetary Fund expects China to have a 2010 current surplus of more than $450 billion — 10 times the 2003 figure. This is the most distortionary exchange rate policy any major nation has ever followed.»

His recommandation to solve the problem:

… « 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. »

Scott Sumner (The Money Illusion) disagrees and accuses Krugman of practicing “pop internationalism” (the title of a well known Krugman book and a critique of politicians’ arguments about international trade. He writes in his post “What will economists 40 years from now think of us?”:

« How many economists today honestly think that if the Chinese give us another 25% revaluation that this will significantly improve America’s economy? And how many of you think that 40 years from now, when we look back on the American economy in 2010, that most economists agree with Krugman’s argument that a significant part of our economic problems were due to an overvalued yuan? In contrast, how many people think that 40 years from now most economists will agree with Krugman’s claim that our economic dilemma is due to the stubborn refusal of the Fed to set a higher inflation target?

My claim is that in 40 years most economists will agree with Krugman. I mean the good Krugman. The guy who wrote Pop Internationalism. Not the guy who says we’re “stuck” in a liquidity trap and who ends his NYT editorial with the crude populist slogan “It’s time to take a stand.” »

The Economist finally may be right in concluding that:

« A speedy end to the dollar peg makes economic sense for China as well as for the world. A stronger, more flexible currency would make it easier for China to control inflation and asset bubbles. A dearer yuan would also help rebalance China’s economy towards domestic spending by boosting Chinese consumers’ purchasing power, discouraging excessive investment in manufacturing and squeezing corporate profits. That would put the global recovery on a steadier footing, especially if a stronger yuan were mirrored by appreciation of the currencies of other Asian emerging economies. And China would gain politically by helping to diffuse protectionist pressure from abroad.

But it would not be a magic bullet, either within China or outside. Rebalancing China’s economy will require big structural reforms, from tax to corporate governance, as well as a stronger currency. A stronger yuan would not suddenly bring back millions of jobs to America. Since America no longer makes most of the products it imports from China, a stronger yuan would initially act more like a tax on consumers. »

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