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February 24, 2006
Michael Darda doesn't think it's manipulation either
PGL (Angry Bear) points us to Darda's piece in the National Review Online:
The neo-mercantilist flat-earth society, which includes members of both parties, doesn’t seem to understand that a fixed (and now sliding) peg for the Chinese yuan simply means that China outsources its monetary policy to the Fed. This is no different from the benefits many countries have achieved by scrapping their own currencies in favor of the dollar. It is telling that the anti-China crowd in Congress has not taken aim at other dollar-linked or dollarized countries with destructive tariff proposals or charges of currency manipulation. Where are the tariff threats or cries of currency manipulation against Ecuador, El Salvador, East Timor, Panama, Lebanon, Hong Kong, Saudi Arabia, Kuwait, or Malaysia, all of which either use the dollar as legal tender, fix their currencies to it, or manage them in a tight band against it? Fixity is the antithesis of manipulation, not the cause of it. Apparently a passing grade in Economics 101 isn’t a prerequisite for ascending to the U.S. Senate.
As Nobel Laureate Robert Mundell recently argued, an appreciation of the yuan could impose deflationary pressures on the Chinese economy, fan tensions in rural areas, and cut China’s growth rate. The result likely would be slower Chinese growth and lower incomes, which would cut the demand for U.S. exports — precisely the opposite of the intended effect. While a modest appreciation of the yuan probably would carry few risks given the dive in the dollar’s value during the last few years, a significant appreciation would surely be deflationary.
It is also quite telling that the strongest advocates of yuan appreciation (or tariffs on Chinese goods) never advocated a devaluation of the currency when China was dragged into deflation by the steady appreciation of the greenback. In other words, the protectionists in Congress want it both ways, which means they are both inconsistent and wrong.
PGL agrees with Darda two respects: his disdain for trade protection and his respect for Robert Mundell. But in the comments to his post, PGL says that Darda gets it wrong in saying a fixed exchange rate is not manipulation. As I stated here, I'm of the opinion that it's not manipulation as well.
For me it comes down to this. China made a decision over a decade ago to fix its currency to the dollar. This was before the massive explosion of growth and before the Asian financial crisis. They have managed one of the most successful hard pegs in the region, and it probably saved them a lot of grief during the crisis of 1997-98. On the other side of the crisis, they kept that peg right where it had always been. The stability of the currency was, no doubt, part of the reason that so many firms wanted to invest there in spite of the strict capital controls. Yet, the fact that they had kept such a hard peg for so long began to work against them. With all that growth, people recognized that this exchange rate would not work forever. Revaluation is inevitable, but when?
It was at that point that this situation became a game theory exercise.
Most people also realize that a large sudden revaluation would be bad for China. This is a gradual process. Too gradual for some tastes. But I can't fault the Chinese for erring on the side of caution. I might fault them a little for things like this... I won't say I'm totally happy with the way things are progressing. But I don't think a 27.5% tariff is the answer. That's short term thinking for a long term problem.
I will say that Darda's complaint "Where are the tariff threats or cries of currency manipulation against Ecuador, El Salvador, East Timor, Panama, Lebanon, Hong Kong, Saudi Arabia, Kuwait, or Malaysia...?" is a little disingenuous. Comparing China to East Timor? Please. The stakes are higher with China, and I think we have a right to dialogue with them about the pace of reform. But I don't like using protectionist rhetoric to get them to dialogue. Maybe some people think that talking tough on tariffs will force the Chinese president to listen to us when he visits Washington in April. I'm not convinced by that argument. On the contrary, it could backfire.
To sum, the yuan is undervalued, revaluation is inevitable and we should work with them to make sure that it happens at a pace that promotes stabilization in the region. But to threaten tariffs when China is moving in the right direction (and when just 4 months ago the Treasury seemed satisfied with the process) sounds like we're playing election year politics with a process that will necessarily play out over a much longer horizon. Justifying it by calling them "currency manipulators" doesn't do it for me. Like many of you, I lean towards flexible exchange rates. I hope that someday China's economy is healthy enough to float more-or-less freely with the dollar. The Chinese are simply more patient about how to get there than many of us are.
Posted by William Polley at February 24, 2006 07:30 PM
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Comments
A nice post as I noted over at Angrybear today. Brad Setser had more on this issue (which I link to).
Posted by: pgl at February 26, 2006 05:10 PM