Here are some prerequisites: the value of currency in China, in contrast to, say, the British pound, is not determined by supply and demand. Instead, the Chinese government set the target rate by buying and selling their currencies on the foreign exchange market. Such a policy is possible due to a restriction on private investors to move funds within the country and beyond.
There is nothing wrong with such policies, especially given the fact that it is still a very poor country, the financial system which can easily be destabilized by volatile flows of “hot money”. Indeed, such a system was very useful to China during the Asian financial crisis of the late 90s. The key question now is whether the target value of the yuan is reasonable.
Until about 2001 it was possible to argue that the price was reasonable: China’s overall trade position was not too far from equilibrium. Since that time, however, the policy peg pairs yuan / dollar is becoming more and more bizarre. First of all, the dollar is declining, especially on the Euro, therefore, maintaining a fixed rate of the yuan / dollar, the Chinese officials, in fact, engaged in the devaluation of national currency in relation to all others. Meanwhile, increased productivity in the export industries of China, coupled with the actual devaluation has made it extremely cheap Chinese goods on world markets.
The result was a huge surplus in trade balance. If demand and supply was allowed to play a crucial role – it would have dramatically increased the value of Chinese currency. But Chinese authorities did not allow such a development. They kept the cost low by selling large amounts of currency, instead of acquiring huge holdings of foreign assets, mostly in dollars, at present, velchichina assets of approximately $ 2.1 trillion.
Many economists, including myself, believe that the consumer boom has helped inflate asset bubble in the housing sector, creating conditions for the global financial crisis. However, China still insists on maintaining a pair of yuan / dollar at a fixed level, even though the dollar is falling, which could cause even more harm to the present.
Although it was a lot of thinking about the sinking dollar, nevertheless, this reduction is actually a natural and desirable. The U.S. needs a weaker dollar to help reduce the trade deficit, and it turns out that the weak dollar as jittery investors, who were drawn to a safe U.S. government debt at the peak of the crisis, but has already begun to invest their money in other places.
But China kept its currency pegged to the dollar. This means that a country with a huge trade surplus and rapidly recovering economies in countries whose currency should rise in value, in fact, engaged in the devaluation.
This is particularly bad at the moment when the world economy remains deeply depressed because of inadequate aggregate demand. Continuing a policy of weak currencies, China grab part of the inadequacy of demand from other countries, which are detrimental to growth everywhere. The most affected are likely to work in other poor countries. In normal times I would have been one of the first who denied the allegation that China is stealing other people’s work, but now it is a simple truth.
So what are we going to do?
American officials have been extremely careful about the problems associated with China, to such an extent that last week the Finance Ministry, expressing “concern” and speaking before Congress, announced that Cathay is NOT manipulating its currency. They’re joking, right?
The fact is that at the moment this political correctness is irrelevant. Assume that the Chinese have begun to do what so afraid of Wall Street and Washington: began to sell part of their dollar reserves. In the present circumstances it may even help the U.S. economy, because such actions will make our exports more competitive.
The fact that some countries, especially Switzerland, tried to bolster their economies by selling their currency to the currency markets. United States, mainly for diplomatic reasons, can not do this, but if China decides to do so on our behalf, we will send them a thank you letter.
The fact that the world economy is still in a difficult position, policy toward “beggar-thy-neighbor” is not acceptable major players. But something must be done with the Chinese currency.