Cost of unleashing China's currency

Congress: Be careful what you wish for.

from the July 13, 2007 edition

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China's exchange rate is a very small factor in US job losses in manufacturing. US productivity gains are far more important. Jobs lost to China and other countries are compensated by job gains elsewhere in America's flexible and growing economy. In fact, US unemployment is remarkably low in spite of the trade deficit.

Critics of China's currency system need to be careful what they wish for. Appreciation of its currency will not reduce America's global trade deficit by much and it will create few if any US jobs.

Completely freeing China's currency and capital flows could backfire. China has the equivalent of more than $4 trillion deposited in relatively weak banks earning barely more than 2 percent after taxes. Freeing China's currency and capital flows would allow some of this money to flow to safer and more lucrative uses in other countries, causing the Chinese currency to depreciate.

Conversely, if China suddenly stopped intervening in the foreign exchange market, it might trigger a sharp short-run decline in the international value of the US dollar and drive up US interest rates. That could cause a housing market collapse and a recession.

How did this problem arise? At the turn of the century, China's leaders finally achieved a reasonably well-balanced trade account. Rapidly rising exports were offset by imports that were growing equally fast. Economic growth was coming from housing, cars, infrastructure, and retail sales. Then an explosion of US imports and Chinese exports wrecked the balance.

Following the NASDAQ collapse in 2000, US consumption exploded due to relaxed monetary policy and a large swing in the federal budget from surplus to deficit. These policies kept the recession short and mild, but they also sucked in imports and created a massive US global trade deficit. China's exchange rate had very little to do with this. The US housing boom financed greatly increased consumption and removed the need for household savings, so American imports ballooned.

Second, Japan's huge trade surplus is increasingly credited to China. As Asian countries move final assembly of computers, shoes, and much else to China, the former surpluses of Japan, Taiwan, and Hong Kong increasingly show up as China's, while the good jobs and profits largely remain in those other places.

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