CHINA MUST HAVE THE COURAGE TO SAVE LESS / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( A MUST READ )

China must have the courage to save less

By George Magnus

Published: September 20 2010 20:48

The renminbi, not for the first or last time, is the subject of a cacophonous debate in Washington and rising tensions between the US and China. When this happened in the spring, a series of confidence-building measures culminated in Beijing’s announcement in June that it would allow its currency to trade more flexibly. Sabre-rattling and subsequent de-escalation has become a pattern but with every occurrence the risks of new financial and economic turbulence are growing.

Recent US pressure on the issue, including last week’s referral by the administration of two complaints against China to the World Trade Organisation, can be explained partly by the unstable nature of US politics ahead of November’s Congressional elections. But this is about more than the need to curry favour among voters. Rather, the two giants of the world economy – one the biggest debtor, the other the biggest creditor – are skirmishing over how the global system should work in the aftermath of the financial crisis. At its heart, the debate is about who is to blame for economic imbalances and whose responsibility it is to right them.

For once, the answer is simple. The US and other western nations have been shocked into saving more and lowering private and public debts over the coming years. It follows that, if the world system is to function smoothly, someone has to save less. China and the other creditor nations are now in pole position to take the needed initiatives.

Yet Beijing seems unwilling to bend significantly. When the renminbi flexibility announcement was made three months ago, I suggested that it was a smart diplomatic move but little else. The currency barely moved until the beginning of September, since when it has risen more quickly to stand just over 1 per cent higher than in June. The timing of the most recent move up can be explained partly by the China-bashing chorus in the US and partly by the imminence of high-level political meetings and negotiations.

China has a strong argument that a higher renminbi would not help much to lower the US trade deficit, which is only partly about prices and much more about structural phenomena that underpin savings and investment imbalances in both countries. Japan’s intervention to weaken the yen last week also gives China cover to resist a higher renminbi. The near-silence in Washington on the Japanese move can only be understood in Beijing as targeted hostility. The presumption must be that Japan is no longer seen as a commercial threat, while China is both this and political rival.

Even so, a concession on Beijing’s part would not only be strategically astute; it would also accord with national interests. While holders of US assets – not least the central bank – would suffer under a large appreciation, a stronger renminbi is entirely in keeping with the shift to a more consumer-centric economy that is widely debated in Beijing. The longer this is deferred, the bigger the economic shock will be when it comes.

Although the exchange rate is the focus of attention, China’s underlying problem is an economic system that sustains national savings at more than 50 per cent of gross domestic product. Little will change unless an array of institutional, corporate, labour market and social security reforms are introduced to rebalance the economy towards local production and consumption. It will not happen without a big push.

Currency disputes are historically about deep-seated imbalances in the global economic system that demand corrective action and high levels of co-operation by both debtors and creditors. This does happen, for example during the Bretton Woods era and perhaps for a short time following the Plaza Accord, which has its 25th anniversary this week. But we know only too well that these were exceptions.

What is needed is global leadership. Unfortunately, both Washington and Beijing have been distracted by domestic constituencies. But creditor countries such as China are invariably better placed to take a lead, even if their reluctance is legendary. Here the US would make a difference if it could convince China that it was serious about lowering the budget deficit and public debt over time.

This will not be easy. The US lacks the political will to come up with such a plan, probably until after the 2012 presidential elections at best, while China is unlikely to embrace large-scale economic and social reform until after the 2012 leadership changeover. There is only so much the US can do in any event. In the end, it is China that must be persuaded.

Premier Wen Jibao’s visit this week to the UN poverty summit in New York and to see President Barack Obama will be an opportunity to calm things down, not least because the US Treasury is scheduled to publish its latest semi-annual currency report in mid-October. This might accuse China of manipulation, a charge that could entail bringing the case to the WTO and the imposition of tariffs.

If, for their own reasons, the US and China are unable or unwilling to engage with each other over trade and exchange rate issues, the chances of collaboration in other vital policy matters look slim. Failure would leave a vacuum, which could only be filled by protectionism. In that event, the process of deglobalisation would have begun – and that is nobody’s interests, least of all China’s.

The writer is senior economic adviser at UBS Investment Bank and author of Uprising: Will Emerging Markets Shape or Shake the World Economy?

Copyright The Financial Times Limited 2010