Chin Music for China

Last month, two guys known for being handy with slide-rules were trash-talking about balls and bats. Paul Krugman of Princeton University proposed policy hardball over China manipulating its currency. Stephen Roach of Morgan Stanley said that was wrong and suggested taking the bat to Krugman.

Look, I may have been the last pick of every ball team I ever played on, but I have been in Chinese business and finance since 1986 and I have some things to interject between the heavy hitters.

For years we have heard the words “currency manipulation” and “China” together so often that they sound as natural as “Mantle and Maris”. But the yuan was stable from 1994 to 2005, it rose almost 20% against the dollar in the next three years, and has been stable since then. Stability like this is not most people’s idea of “manipulation.”

Those who talk about China manipulating its currency are trying to de-legitimize its fixed exchange rate system, but it is legal and valid. The articles of agreement of the International Monetary Fund permit nations to choose fixed exchange rate systems. When the United States pressured the IMF to condemn China’s arrangements, the IMF responded with the brush-back. In 2005, Managing Director Rodrigo de Rato said there’s no evidence of manipulation for competitive gain: “There is a strong argument by the Chinese authorities that their main objective . . . is the stability of the economy.”

Still, the criticism of the Chinese returns with a regularity that it is more Groundhog Day than Opening Day. In 2004, Senator Chuck Schumer said that “many economists estimate that the yuan is now undervalued by between 15 and 40 percent.” In 2009, he said, “China’s currency remains between 21 and 40 percent undervalued against the dollar.”

What happened between 2004 and 2009? As we’ve seen, the Chinese currency appreciated against the dollar. Since the currencies of other countries appreciated about as much, it did not change the context of the US-China trading relationship. The American side can therefore keep on claiming up to 40% undervaluation of the yuan as the dollar drops.

Let's focus on that point. The US dollar has declined in this decade against other currencies in response to American economic conditions and policies that drive it down. Yet the American view is that the yuan is manipulated just because it tracks the dollar’s slide.

It’s wrong-headed, as is the implicit American view that exports will rise if we just weaken the dollar enough. If exchange rates were the key factor in trade competitiveness, then Mexican imports would have streaked ahead of Chinese in the US market at times of peso weakness and Zimbabwe would be the biggest bat in world trade.

Worse frustration is to come. Partly in response to US pressure, partly for its own good reasons, China will alter its currency peg – yet absent other major structural changes, this will not swing the trade balance.

American exporters export, whatever the exchange rate. In the most recent reported quarter, exports accounted for a big 1/3 of the value of goods produced. No one with an idle plant in Paterson NJ is basing the decision to restart production mainly on the Chinese yuan exchange rate.

However, goods production is down to just 23% of GDP. The US economy has gone post-industrial. Clearly our trading partners only buy our manufactures to the extent that we manufacture. They buy none of the output of our government sector. They buy some services, but in a recession they too have less need of services in which American business specializes.

Here’s a difference between Chinese and American business today. A Chinese entrepreneur might as well try his hand at manufacturing, but the American thinks long and hard before taking up the regulatory and tax burdens of making a product for sale.

It's one reason serviceable industrial parks hereabouts rent to ballet schools, medical offices, day care centers, basketball clinics, gymnastics facilities, skate parks, art studios, martial arts gyms, fitness centers, houses of worship, schools, and even government offices, but less and less to industry.

China's scouts might look at Japan’s play since the last time it contended, and conclude China has little to gain by playing ball with the Americans. There was a huge rise in the value of the yen from 250 to the dollar in 1985 to 90 in 2009. However, this neither stopped the US from placing trade restrictions on Japan, nor dissuaded the Japanese from investing heavily here. And after all that, America runs about the same trade deficit with Japan now as it did in 1985.

At that time, by the way, one Chinese yuan bought 75 Japanese yen. In 2009, it bought only 13, but despite that, Japan still runs a trade surplus with China.

In neither situation was the exchange rate the key factor.