Currency contortions

Dec 17th 2009 From The Economist print edition Tensions are likely to rise further over China's exchange rate Illustration by M. Morgenstern A COMMUNIST leadership always on full alert for violations of national sovereignty has lately grown shrill over calls by American and European policymakers to raise the value of the Chinese yuan, kept low by a heavily managed currency regime. Recently the prime minister, Wen Jiabao, presided over a grumpy summit between China and the European Union. There he berated his guests for their “unfair” pressure to revalue the yuan. The mantra of Mr Wen and other Chinese leaders is that the yuan ain’t nobody’s business but their own. This message cannot be immune forever to reason, and an almighty international ruckus over the Chinese currency looks likely in the coming months. A tiny economy may enjoy what Martin Wolf, a columnist at the Financial Times, calls “the liberty of insignificance”. But China is the world’s largest exporter, with $2.3 trillion of foreign-exchange reserves. The scale and consequences of its currency regime are alike unprecedented. A fast-growing economy with the world’s largest current-account surplus ought to see its currency rise. Instead, China’s is sinking because the yuan is in effect pegged to a falling dollar. The yuan has fallen by 14% against the euro over the past ten months. The real trade-weighted exchange rate is back to where it was in 2002, despite moves to revalue the currency in 2005. That is one reason the value of the yuan cannot be solely a domestic matter. Another has to do with “global rebalancing”. Simply put, American households need to repair their balance-sheets by paying down debt. That implies a rise in American saving, a fall in American consumption and an increase in exports, helped by a cheaper dollar. The best outcome for global growth would be for American belt-tightening to be matched by a rise in consumption in countries with current-account surpluses and savings to spare, China above all. Yet China’s exchange-rate policy shifts the adjustment onto others. China bridles at the criticism. Its officials say that though the yuan has fallen this year, it has risen against most other currencies except the Japanese yen since the start of 2008. Moreover, a year ago, China embarked on a huge fiscal stimulus. Its 4 trillion yuan ($586 billion) package has been a success. China is growing strongly whereas most rich countries are in recession. How dare others say it is not pulling its weight? The Chinese have a point. Their stimulus-induced boom has buoyed up the world economy and contributed to global rebalancing. Its huge external surplus has almost halved. But the worry is that the nature of the stimulus—focused on state-directed lending for investment—will perpetuate a lopsided economy. Especially if the stimulus encourages over-investment in sectors already burdened with too much capacity, current-account surpluses could surge once again in future. Some of these fears are probably exaggerated. China is enjoying a property and construction boom, which should boost consumption in future. But the hard truth is that China’s economy is still too dependent on investment and exports, a dependence that the stimulus has not changed. This will prove particularly problematic if America is really serious about raising its saving rate and reducing its appetite for Chinese goods. China needs to shift faster to a new economic model that emphasises consumers over producers, something often portrayed as a matter of unleashing the suppressed spending power of a high-saving population. Actually, as even a cursory trip through China would tell you, the country has been in the grip of a consumer boom for years, with car sales rising by over a third a year, and huge demand for travel, consumer goods and housing. Rebalancing, Jonathan Anderson of UBS argues, is not a matter of addressing household savings which, though high as a share of people’s income, is not abnormal as a share of the national cake (because incomes are a small share of the economy). Rather it is corporate saving that has seen a sharp rise. Corporate saving lies at the heart of China’s “excess” savings and the rise in the current-account surplus, from 2.8% of GDP in 2003 to 11% at its peak. The profits hoarded as a result, Mr Anderson argues, represent market share grabbed from foreign producers with the aid, this year, of a cheap currency. Rebalancing through a rise in the exchange rate would be one way to shift those savings back. The corporatist state As for what China’s leaders will now do, the signs don’t bode well. The leaders say a stable currency plus the stimulus are the anchors for President Hu Jintao’s trumpeted notions of a “harmonious society” and a “new socialist countryside”. That is, they create jobs. But not enough. Chinese growth is heavily skewed in favour of investment, not employment. Joblessness in large export sectors (consumer goods, electronics, and so on) does not seem to bother the leaders unduly. When exports collapsed a year ago, migrant workers in the factories melted back into the countryside. Indeed, if the leadership really cared about domestic demand, it would presumably not send quite so much of it abroad in the form of vast current-account surpluses. No, the leaders are in thrall not to the workers but to vested interests in state-run heavy industry and finance. In turn, the Communist Party guards its power by controlling the taps of a banking system that takes below-market-rate deposits from China’s households and passes them for next to nothing to the country’s corporate borrowers. This is no people’s republic. Whatever the economics of the currency regime, the politics of it are clear: the Communist Party is listening to the concerns of state-owned enterprises. And that is why Mr Wen and his colleagues not only decry debate about the exchange rate abroad. They also squelch debate at home.