By Martin Wolf
Published: November 17 2009 20:06
Barack Obama, president of the US, met Hu Jintao, president of the People’s Republic of China, for a private meeting on Tuesday. The agenda was long, covering the world economy, climate change and non-proliferation of nuclear weapons. The last two are the most important, over the long run. But the first is the most urgent. If we do not achieve a healthy global economic recovery, hope of a co-operative relationship is likely to prove vain. Yet such a recovery is far from ensured. Worse, some of what is now happening – particularly China’s decision to depreciate the renminbi along with the dollar – makes healthy recovery less likely.
This, then, was an opportunity for Mr Obama to tell some brutal truths. I hope he did, after careful briefing from his staff, on the following lines.
“Mr President, as I said in Japan, ‘the US does not seek to contain China, nor does a deeper relationship with China mean a weakening of our bilateral alliances. On the contrary, the rise of a strong, prosperous China can be a source of strength for the community of nations’. For the foreseeable future, our two countries will be the leading players on the world stage. We must approach our challenges in a spirit of co-operation and accommodation. But that is, alas, not happening over your exchange rate policies.
“Chinese officials have expressed understandable concern over US fiscal and monetary policies. Most recently, Liu Mingkang, your chief banking regulator, has argued that the combination of a weak dollar with low interest rates had encouraged a ‘huge carry trade’ that was having a ‘massive impact on global asset prices’. Similarly, many Chinese officials complain about our huge fiscal deficits and worry about the safety of Chinese investments in US Treasury bonds.
“I do share these concerns. But our current fiscal and monetary policies have a straightforward cause: we were contemplating the abyss a year ago. Even now, our recovery is too weak to reduce unemployment from intolerable levels. Confronted with these risks, the Federal Reserve and my administration have acted to sustain demand. If anything, those who warned our stimulus package would prove too small were right.
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“We faced a slump for a simple reason: the financial crisis we inherited triggered a collapse in US private spending and a sharp rise in private saving. My advisers have told me that between the fourth quarter of 2007 and the second quarter of 2009, the balance between US private income and spending shifted from a deficit of 2.1 per cent of gross domestic product to a surplus of 6.2 per cent – a swing towards frugality of 8.3 per cent of GDP. The collapse of our fiscal position is no more than the mirror image of this shift in the balance between private income and spending. The Fed’s easing is also an inevitable response to the collapse.
“I am president of the US. I am not going to put our economy into a depression, to protect the value of Chinese savings. After all, nobody in the US asked you to intervene on so massive a scale in currency markets and so accumulate the incredible total of $2,275bn in foreign currency reserves by September of this year, much of it in our currency.
“The policy China apparently recommends to us would not even work on its own terms. Suppose the Fed stopped quantitative easing and raised interest rates, to strengthen the dollar, while we pushed through a huge fiscal tightening. This would return the economy into a slump. Thereupon the fiscal deficits would surely worsen, once again.
“As Dominique Strauss-Kahn, managing director of the International Monetary Fund, has just pointed out here in Beijing, ‘at the end of the day, higher Chinese domestic demand, along with higher US savings, will help rebalance world demand and assure a healthier global economy for us all’.
“I recognise that China has played an invaluable role by stimulating domestic demand and so facilitating needed global adjustments. The IMF apparently expects a huge decline in China’s current account surplus this year. Unfortunately, that may well prove temporary: first, your stimulus programme, with its reliance on massive credit expansion, may prove unsustainable; second, the decline in China’s trade surplus is largely the result of the crisis-induced collapse in world trade; and, third and most important, China has embarked on currency deprecation by locking the renminbi to the falling dollar.
“At a time of such weak global demand, yours is a ‘beggar thy neighbour’ policy. You complain about the protectionist actions I have implemented. But their impact will be trivial compared with China’s ‘exchange rate protectionism’. This policy will shift the costs of adjustment on to China’s trading partners. Yet, again in Mr Strauss-Kahn’s words, ‘a stronger currency is part of the package of necessary reforms. Allowing the renminbi and other Asian currencies to rise would help increase the purchasing power of households, raise the labour share of income, and provide the right incentives to reorient investment’.
“You have, I am sure, decided that such lectures mean nothing. What you may fail to understand is the speed with which democracies can shift their attitude from the open hand to the clenched fist. If, over the next year or two, your current account surplus exploded upward, while our deficit did the same, it would be impossible for us to ignore. This is particularly true when sober analysts – Goldman Sachs, in this case – estimate that, on its present path, China might have a bigger surplus, relative to world GDP, by 2020, than ‘the combined surpluses run by Germany, Japan and Middle Eastern countries in 2007’.
“Yet we do not have that much time. If the US domestic economy remained weak and unemployment high, while our trade deficit soared, particularly our bilateral deficit with China, the pressure to ‘do something’ would become irresistible. I would have to consider the sort of actions that Richard Nixon took in 1971. To force revaluations by Germany and Japan, he threatened a 10 per cent import surcharge. With great regret, I might feel obliged to do the same. I would then argue that China’s determination to thwart needed adjustment in exchange rates had become intolerable. The US is entitled to protect itself against such mercantilism. The trading system would be terribly damaged. But the alternative would be unbearable.”
Did Mr Obama speak so bluntly? Probably not. Should he have? Yes, I think he should. We have spent long enough discussing China’s exchange rate policies. It is time for action.
Copyright The Financial Times Limited 2009
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