FT.com | Willem Buiter’s Maverecon | When all else fails, blame China

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Willem Buiter
When all else fails, blame China

January 24, 2009

Timothy Geithner, the nominee for US Treasury Secretary, has risked damaging the global economy even before his confirmation by the full Senate. In a written answer to questions from US senators, Geithner said: “President Obama - backed by the conclusions of a broad range of economists - believes that China is manipulating its currency”. In the US, the words “currency manipulation” are fighting words. If the US administration were to formally name China as a currency manipulator, a range of trade sanctions could be imposed by the US government...

...In any case, as Chart 1 below shows, there has been a steady appreciation of the real effective exchange rate of the Yuan since the beginning of 2005. JP Morgan’s broad real effective exchange rate index for the Yuan shows a 27 percent real appreciation since December 2004. The from a macroeconomic perspective uninteresting nominal bilateral US$-Yuan exchange rate appreciated 21 percent over the same period...

...The US is proposing policy measures that will increase its external deficit. The $825bn fiscal stimulus over two years proposed by the Obama administration will increase the US current account deficit. It will also strengthen the real effective exchange rate of the US dollar, unless there is a loss of faith in the ability of the US sovereign to service its debt in the future through higher taxes or lower public spending. In that case the nominal exchange rate could decline sharply, taking the real exchange rate with it in the short run, as market participants dump the US dollar and US dollar-denominated securities because they fear either a monetisation of public debt and deficits or a sovereign default.

So China is undertaking actions to remedy its own external imbalances and global imbalances. The US is proposing measures to increase its external imbalances and aggravate global imbalances. Instead of saving more, the US government is desperately trying to get the already over-leveraged US consumer to save less. And just in case the US consumer balks at the fiscal carrots dangled in front of him, the already fiscally challenged US government is proposing to reduce its own saving and increase its own investment.

The last thing the US economy needs is a large fiscal stimulus, or indeed any fiscal stimulus at all. A good argument can even be made for a US fiscal tightening. Expansionary monetary policy is the only instrument available to the authorities that will both boost the US economy and correct its external imbalance. With the Federal Funds target rate as close to zero as makes no difference, only aggressive quantitative easing and qualitative easing (what Bernanke calls credit easing) are available and the magnitude and timing of their impact is uncertain. That’s tough, but that’s the way it is. The belief- the faith almost - that there has to be a painless way out of the US economic dilemma is naive and will be disproven by economic record of the coming years. The notion that currency manipulation by China is a material contributor to America’s external trade deficit is either a dangerous form of self-delusion, or an even more dangerous form of pandering to xenophobic Congressional opinion, or both.

Conclusion

One reason I still nurture the hope that the current global recession will not become a second Great Depression, is that there has been no significant recourse to trade restrictions by countries trying to export their domestic demand deficiencies to their neighbours. There has been increased use of anti-dumping measures - the first recourse of the modern protectionist, beggar-thy-neighbour scoundrel - but less than might have been expected given the prevailing spineless political leadership around the globe. As unemployment and excess capacity increase, and corporate bankruptcies multiply, the calls for protection against ‘unfair’ foreign competition will multiply. Any excuse - environmental, social, labour standards, phyto-sanitary, national security - will be used to allow domestic industry and labour to find shelter from the storm. Old-style protectionists like Sarkozy find new converts such as Merkel, to push protectionist measures, including state aid for non-systemically important industries like automobile manufacturing.

So while the protectionist genie is not yet out of the bottle, it is kicking and pushing against the cork, trying to escape. The verbal sabre rattling by US Treasury Secretary Geithner is a threat to the open global trading system. More stupidities along the same lines could bring us the global trade conflict that we have been fortunate to avoid thus far.

Comments

Geithner’s words were not a slip of the tongue, they were premeditated and deliberate. They were meant to announce protectionism.

Same as it ever was.

The story of mankind is the story of Sisyphus.

We are doomed to repeat our mistakes over and over again, I fear.

Posted by: Martin