International Herald Tribune
Bowring: The global imbalance
Tuesday, January 27, 2009

HONG KONG: The new U.S. secretary of the Treasury, Timothy Geithner, has sparked a potentially acrimonious debate by alleging at his confirmation hearings that China manipulates its currency. This may be politically necessary but it's not helpful. The currency debate has become sterile, obscuring a bigger and, for the global economy, more difficult issue: China's huge current account surplus, which is no longer just a mirror of U.S. deficits.

Geithner is right in some ways. China does keep tight control of its currency's value, which is easy enough given strict exchange controls, the size of its reserves and government ownership of major banks. For years China has followed a policy of export-led growth. Beijing now finds it difficult to shift away from this, even though it knows there is scant sense in accumulating ever bigger trade surpluses and reserves. Recently, Beijing has been under pressure from Chinese exporters to stop appreciation of the yuan. Layoffs are now a political problem for Beijing.

However, it is wrong to assume that just because the yuan has in recent months stabilized against the dollar after years of slow appreciation that China's currency is being manipulated to sustain exports. Over this period, the dollar has been strong and the yuan has risen steeply against European currencies, the Canadian and Australian dollars and the South Korean won, and moderately against most other Asian currencies, except the Japanese yen. On a trade-weighted basis, China's currency has appreciated by about 10 percent since August.

There is little evidence that China manipulates specifically to help exporters or sustain a trade surplus. Its desire to move closer to the U.S. dollar rather than simply follow a trade-weighted basket is a natural outcome of the denomination of most of its trade in dollars. Beijing's reluctance to moderate appreciation of the yuan against the dollar is also natural because it creates losses for China's central bank - whose assets are in dollars and liabilities are in yuan.

The real problem that China presents to the world is its current account surplus, which is about 8 percent of national output, or $350 billion a year. In the past this has been mostly a mirror of the deficits of the U.S., Britain and Australia. But as those countries go into recession, as savings begin to rise after years of debt-driven consumer bingeing, those countries' imports, not least from China, will shrink accordingly. It is quite possible that the U.S. trade deficit will disappear within two years.

That would be fine if something else was not also happening. China's own slowdown has been a major factor in driving many commodity prices to multiyear lows. The result is that while China's export surplus with the industrialized world is shrinking, its overall trade balance is increasing. Some economists are now forecasting that China's current account surplus could hit 9 percent or even 10 percent of GDP. In other words, global imbalances are getting even worse.

Some of the gains from lower commodity import prices for China (and other exporters of manufactured goods) are nothing to worry about. The oil exporters of the Gulf, Norway and elsewhere do not need more income that they cannot spend. But the simultaneous contraction of deficits in a developed country, particularly the U.S., with the rise in the deficits of the developing world will put new strains on the global system.

The U.S. can run a deficit simply by printing more dollars. The likes of India, Brazil South Africa and Indonesia cannot. They will have to borrow to sustain economic growth when their export prices fall. With private sector finance now hard to find, and given the limited resources of multilateral institutions like the World Bank, the dangers of a downhill snowball effect are clear.

That suggests that the world badly needs China's domestic demand to grow fast, both to pull in more exports and push up commodity prices.

Further yuan appreciation is marginal to the speed with which China's domestic stimulation works. That will not be easy given China's massive over-investment in some industries and construction projects, and lack of consumer buying power in an investment-obsessed economy.

The key message for China must be how important its stimulus is for global balances as well as its own economy. It needs encouragement from its trade partners. Sniping about currency manipulation is unlikely to put China in a responsive mood, and is a worrying example of how U.S. domestic perceptions can obstruct its global leadership role.