Dr.Paul Krugman, a Nobel prize winning economist and a NYTimes columnist in his recent article (http://www.nytimes.com/2010/01/01/opinion/01krugman.html), talks about how China's policy of not allowing its currency to appreciate is hurting the world markets and the US in particular. He also argues that in any kind of trade confrontation with China there is little to lose for the US. He has some valid arguments that with the interest rates already at an all time low in the US, any kind of slow down in buying American treasury bonds by the Chinese is not going to affect US interest rates in the short term(since the interest rates are already very low and will not be increased at the current economic scenario. Chinese used to do this to keep their currency artificially low against US dollars which benefits Chinese exports). Also, Dr.Krugman argues that the protectionist policies will follow if China doesn't allow its currency to appreciate. Dr. Krugman also says that his back-of-the-envelope calculations show that China's current currency policies will reduce US employment by around 1.4 million jobs in the next couple of years.
I agree with Dr.Krugman that the policy of keeping the Chinese yuan (renminbi) artificially low is affecting many other export markets and I can see that particularly many other developing economies' export markets are severely affected. Say if Chinese yuan appreciated in value, this would facilitate exports from other countries where the currency is naturally low. And when exports from these other markets go up, their currency gains in value (if its floating) and that market will become a market for US exports. Also, with the Chinese yuan's value going up, Chinese consumers will have a better purchasing power and China will be another big US export market. When the exports occur from one market and if that market's purchasing power is kept artificially weak then we are stuck in a one-way road.
But I should also say that I have some disagreements. As I have mentioned in my previous post (China's economy and the Yuan), Chinese economy grows mainly on exports. So, any drastic increase in the value of the Chinese yuan (renminbi) will seriously affect the cycle of money flow in China (refer to my previous post) and will cause huge amount of job loss in China. So we cannot even dream of China appreciating its currency drastically as some in the western counties urge it to.
Also, I disagree with Dr.Krugman's 'don't care' attitude even if China doesn't buy American bonds. America doesn't expect China to buy its bonds just to keep its interest rates low but to fund its budget-deficit every year. If China doesn't buy American treasury bonds then the interest rates in the treasury bonds will surely go up and this will only add up to the budget deficit every year. And if this continues, US government will reach a saturation point and will be forced to cut down on the services that it provides to its people.
And Dr.Krugman's point that he would send a "thank you" note to Chinese if they start selling the dollars is very scary. Did Dr.Krugman forget that the US dollar is the international reserve currency and that major commodities are bought and sold in US dollars in the international markets? The export-oriented manufacturing plants in China will not go anywhere overnight. There will still be a large number of goods that need to be bought from China and this will result in an enormous increase in the input costs for American companies that have setup manufacturing plants in China. This will shoot up the prices (read inflation) of the products bought in US and as a result of this the consumer-demand might become weaker which is already at an all time low. And with the world's economies decoupling itself from the western world more and more day by day, the Chinese manufacturing plants will still be needing enormous amount of oil and other commodities. So, if they sell US dollars then this will result in the value of the US dollar going very low and this in-turn will result in inflation in many parts of the world. With the global economy remaining very fragile, this might even cause stagflation in many countries. The loss that will be incurred through the world economy facing such catastrophic economic scenarios will NOT be offset by a weaker dollar that will help American exports.
Another point to consider is, the US interest rates are near zero and the economy is awash with liquidity. We are already fearing inflation if monetary easing is not cut back at the right time. If dollar falls in value in the international currency markets because of China selling its huge reserves then this might result in inflation in the US economy.
Above all there is already a talk in the global stage about replacing US dollar with some other currency (like Euro) as the international reserve currency in the longer-term( Note: Japan and other East-Asian economies are already talking about a common currency). I agree that US dollar cannot be replaced by any other currency as the international currency now and no country is ready to face the economic disadvantages that this action of replacing US dollar will bring. Particularly this will be very damaging to the US economy. But if the weakness of the US dollar in the international currency markets goes beyond a certain amount then this will result in favor of those who argue to replace the US dollar with some other currency as the international reserve currency (again I am talking in the longer-term). Let's say, for example, if OPEC countries think of selling oil in Euros or other currency then this will be very damaging to US.
So yes China should immediately start to change its economic structure. They have started it well with their response to global economic slowdown. And at some point in time, China has to allow its currency to appreciate in value but we need to wait for some more time till China changes its economic structure. China has already introduced a massive stimulus package and this is driving consumer spending. So we need to give China time to appreciate the value of its currency and this is to the advantage of both China and US. But in the meantime, we must think of how we can assist American exports by introducing some incentives. From China's part, as I mentioned in my previous post (China's economy and the Yuan), investment in vital areas such as rural health and education are needed to move the country from being an export oriented economy to an economy driven by domestic factors.
No comments:
Post a Comment