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Blundering on China
Readers of MoneyPolitic$ might be interested in today's unsigned editorial in the New York Sun, "Blundering on China." It has strong affinities with my own views on the subject. VERY strong. (Incidentally, I should mention that I am a columnist for the paper.)
Here's the full text. Enjoy.
Since 1994, when China instituted a quasi currency board system, the Chinese economy, linked to the greenback as its reserve currency and standard of value, has created more prosperity in that huge country than at any time before in its history. Since 1994, real growth of gross domestic product in China has averaged about 9% a year. During this time, in a country previously plagued repeatedly by unreliable money and a volatile but usually high inflation rate, the Chinese consumer price index has risen only slightly above 3% a year. Japan would die for this kind of economic performance. So would Western Europe. Why would anybody in his or her right mind wish to meddle with this kind of economic performance.
Just ask the other developing economies in the Pacific Rim. Neither Free Korea, nor the Philippines, nor Thailand, nor Indonesia, nor Malaysia can boast of this kind of track record. Turn the clock back to 1997 and 1998. All those aforementioned countries were pegged to the dollar and enjoying solid prosperity. So what happened? Robert Rubin's Treasury, along with the geniuses at the International Monetary Fund, decided that these countries should float their currencies and de-link from the U.S. dollar. What happened? The currencies promptly sank.
There's a lesson here. It's a simple one. Emerging currencies don't float. They sink. Why is this? Because they have a history of instability. They do not have a history of monetary value that is reliable. That is why the dollar link was correct in those days and that is why the consequences of this currency meddling by the IMF nearly threw the world economy into a deflationary spiral. And those countries suffered the most, as foreign investment flows were immediately withdrawn. As such money left those countries, their economies shrank, unemployment rose, and in many places there was rioting.
It is precisely this outcome that China seeks to avoid by operating a so-called monetary price rule with the dollar as its lodestar. In effect, the communist Chinese central bank has had the wisdom to restrain its money creation by merely backing international investment flows, which are predominantly dollars and sterling, with new currency units. This is why inflation remains contained while the fledgling Chinese market economy continues to expand at such a hefty pace. In fact, over the past 12 months, the consumer price index of China has registered a tepid 1.8% gain through the dollar peg.
But it's not merely a peg. It's reminiscent of the old Bretton Woods dollar-gold exchange system, when the dollar value was linked to gold as a restraint on the creation of greenbacks. Today, for China, the dollar is, in effect, gold. The greatest monetary error made by America in the past four decades was the one made by President Nixon when, in 1971, he closed the gold window and, in 1973, signed off on the scrapping of all references to gold as a guidepost to American monetary policy. It was this error that opened the era of stagflation, whereby both inflation and unemployment rose together to undermine the American economy and to damage our position in global affairs.
So why would we wish to inflict this kind of damage on a relatively healthy Chinese economy, with its growing benefits for America and the rest of the world? A small appreciation of the yuan would make no difference for cost differentials between America and China. It would take 40% or 50% appreciation, which might level out cost and wage differentials but would in the process create a massive deflation of the Chinese economy and threaten not only its prosperity but that of its neighbors and of our country.
The only thing more dangerous than forcing China off the dollar standard is the protectionist idea being advanced by Senators Smoot Schumer and Hawley Graham. They are advancing the idea of a 27.5% tariff on Communist Chinese imports into the United States. Does anyone remember the Great Depression? It was triggered by, among other colossal blunders, the passage of the Smoot-Hawley tariffs, which not only blocked imports to the United States, impoverishing our businesses and our families. It also triggered worldwide retaliation that set the stage for the flourishing of enemy ideologies that delivered World War II.
We are not against pressing for reform in China. But the right area for American policy-makers to focus is the political side of the freedom equation. The problem with China is not, in fact, that it's managing its currency, as we manage ours, in a stable way. They need to address their human rights problems, end their persecution of religion, open up their polity to multi-party democracy, free their press, further liberalize their economy, and help America confront the nuclear threat emerging from North Korea.
