The Currency Wars and Global Trade Imbalances

In the run up to the Seoul Summit, the issue du jour has become “the currency wars.”

I certainly side with those who think that the under-valuation of the Chinese currency and its fix to the US dollar at that low level constitutes a huge subsidy to Chinese exports  which has played a major role in the creation of large global trade and balance of payments imbalances, especially as between China plus developing Asia on the one hand and the US on the other. The fact that China (like Japan and Germany and the oil exporters) piles up US dollars in huge hoards of sterilized foreign exchange reserves rather than spend them on imports also gives a major deflationary bias to the global economy as a whole.  And it seems pretty clear that the US cannot continue to be the buyer of last resort for the global economy as a whole, letting everybody else grow through exports.

So, something has to give if there is to be sustained global recovery. But I am somewhat skeptical of the majority view (eg of the IMF and the OECD) that an upward revaluation of the renminbi  in and of itself would make all that much of a difference given the underlying structure of global trade under the neo liberal rules of the game.

True, there would be a difference at the margin. The Chinese trade surplus  with the rest of the world would shrink to some degree, and the US trade deficit would shrink to some degree.

However,  it is far from clear that the  US would replace imports from China with US domestic production in a major way.  The US now has very limited capacity to produce mass consumer goods of the kind which arrive by the millions of containers in West Coast ports to be trucked to Walmarts across the nation.  Much of the loss of Chinese market share in the US would go to other developing country producers such as Mexico, whose maquiladora plants have been recently losing production and jobs to China,  and countries like Vietnam which can even today under-cut the “China price”. US and other transnational corporations would tweak their global supply chains to find low cost production sites rather than relocate production back to the US.

In principle, China should contribute to re-balancing by shifting from export led growth to growth led by domestic consumption. This would be a good thing, especially if based not just on a currency realignment but also on rising Chinese wages and the creation of a social safety net which would encourage Chinese workers to buy rather than to save at current sky high levels. The Chinese government seems to be leaning in this progressive direction, as shown by their tacit acceptance or even encouragement of trade union activity.

That said,  Chinese consumption has to grow from very low levels relative to US let alone total global demand, and this will take time.  True, China is now a big economy, but it is net exports and investment which currently make up the lion’s share of demand.  And the US domestic economy has only limited capacity to produce the kind of goods that Chinese consumers will want to buy. If and when China shifts to growth driven by domestic demand, parts of the export oriented manufacturing sector will switch to serving the domestic market, and imports from other developing country producers of mass manufactured goods will rise.

China’s imports are not just low relative to exports, they are also overwhelmingly tilted to raw materials and to sophisticated capital goods. The US obviously has some export capacity in both of these areas, but it is limited. Chinese imports of capital goods come mainly from Japan, Korea, Taiwan  and Europe, and it is hard to see that changing very much.

Put it all together, and an upward revaluation of the renminbi would likely not have a major impact upon the US trade deficit, nor upon US growth and employment.

What then could and should be done?

While currency realignments and a re-orientation of the Chinese growth model would have some impact, I strongly suspect that the US trade deficit is not going to shrink dramatically unless and until there is a major change in US trade policy.  The US could attempt to reach a bilateral managed  trade deal with China to gradually unwind the huge bilateral trade deficit. Effectively, this would mean persuading China to give a preference to US exports as the quid pro quo for coninued access to the US market. Or the US could simply resort to raising tariffs and other trade barriers to limit the growth of imports irrespective of where they come from.

Such measures are, of course, totally inconsistent with WTO rules and the neo liberal trade paradigm. But they are on the US domestic political agenda.

Which is precisely why, one suspects, that Geithner et al are pretending that modest currency realignments would make a significant difference.


  • glad you posted this, I may borrow a bit for my radio labour report tonight- hope you don’t mind.

    I do have a problem with your final point on giving the US preferential treatment. At whose expense? Most likely other developing countries that have unfair advantages- contra the US. However this is a highly punitive framework for change for these countries- ones that can least afford the development- although I am not promoting sweatshops either.

    My feeling is the US should pursue an industrial strategy that promotes the high wage model- innovation and pushing the quality output angle – up skilling and training into the newer economy type jobs.

    I strongly believe there is a strategic choice that must be made in that direction- but it will take a coordinated industrial strategy that will take both public and private interests to work together.

    I am not saying it is mutually exclusive. There are definitely some manufacturing and service jobs that could be repatriated back from China to the US with a little bit of help. However, I would tend to lean towards promoting a multi- pronged strategic choice

    1) the high wage model (although I am not sure the US has the political capacity in terms of oth the private and public sector linkages in anything accept ,the military). High quality goods, green goods, knowledge intensive industries, i.e. software and hi tech.

    2) some preferential treatment for selected industries that are quite obvious- like steel, fabrication industries, auto.

    3) help promote developing economy labour and environmental standards through market access, i.e. codes of conduct and other such measure that have worked somewhat in the garment and a couple other sectors.

    4) the whole green economy innovation strategy- a whole infrastructure and culture of energy consumption awaits to be changed and it will take a lot of work. Figuring out how to pay for it is a problem, but like any battle that must be fought- cost should not be an impediment.

    I am sure Andrew, you would agree with me on many of these points, I just thought I would try and clarify a bit.

  • I do think it’s a bit unfair to put all the blame on China. It’s not like the Chinese are coming into the US, descending on the Fed and forcing them at gunpoint to sell treasury bills. The US economic establishment walked into trade deficits quite deliberately as near as I can make out, and the US political/military establishment walked equally blithely into large budget deficits. They wanted to buy China’s stuff cheap (and many of the US financial elites are heavily invested in the companies selling it), they wanted someone to buy their debt instruments, and China obliged on both fronts.

  • how easily we forget that it is the very same oecd countries that have been aggressively deregulating trade all over the world thus reducing further and further the quotas on imports from various countries -especially china. in the usa alone, the share of imported manufactures coming from china almost doubled from 7.6% in 1995 to 13.8% in 2002 and trade barriers have eroded even more since then. i believe they focused on china to the exclusion of other developing countries in order to have a stable supply of manufactures and commodities while subjecting the rest of the developing world to a severe and socially destructive price-reducing competition. all this to feed the ever growing concentration of buying power in the west, which, when seen clearly, is no real power at all, backed as it is by consumer credit and financed as it is by borrowed money, the debt upon which is largely owned by … china.

    the u.s. is certainly the main author of the ‘balance of financial terror’ as larry summers has called it.

    it seems clear that it is not china’s currency that is UNDERvalued, but the u.s.’s which is OVERvalued. i mean, how is a higher renminbi going to help the u.s. when they don’t themselves produce most of the things they buy from china? it is more likely to accomplish a slower rate of domestic consumption in china, which would actually exacerbate china’s excessive reliance on investments and net exports.

    meanwhile, the u.s. continues to pump air into the bloodstream of the global economy through their desperate policy of ‘quantitative easing’, which, due to the speed and volatility of the ‘capital’ it casts into the market, can immediate devalue the produce of developing nations. this, far more than anything that china is doing, is what is prolonging the crisis and may in the end eclipse any notion of an end to it. is it any surprise that the nations with the largest emerging markets – india and brazil – don’t take the g20, the mandate of which is to facilitate these very economies, seriously any more? it has just become another venue for the u.s.’s and other developed countries’ desperate games.

  • John Mayner Keynes would not approve of the US solution.

    John Maynard Keynes described the situation in The Economic Consequences of the Peace: “The inflationism of the currency systems of Europe has proceeded to extraordinary lengths. The various belligerent Governments, unable, or too timid or too short-sighted to secure from loans or taxes the resources they required, have printed notes for the balance.”

    A path the US currently is on, since 2007-08, the US federal government has borrowed & printed, while currently, not even going to raise tax rates to levels required for the volume of spending by the obama administration; or cut spending to levels required based of current tax rates…

    Instead with the current administration, we get a repeat of GW administration, government spending and low taxes, leading to unsustainable deficits, and higher prices for raw materials, etc.

    Could someone not pick a worse outcome.

    Many of the authors here from Paul to Andrew, and Eric, do you not remember Keynes, arguments. Many of you have tried to point how, for many of minutes, how government spending is far from WW2 figures.

    Trying to make the point, we have room to grow government.

    In World War II, Keynes “the Man” argued in How to Pay for the War, published in 1940, that the war effort should be largely financed by higher taxation and especially by compulsory saving (essentially workers loaning money to the government, which I have stressed and stressed again), rather than deficit spending, in order to avoid inflation.

    I argue, today in peacetime, and citing a relatively low savings rate, how do we pay for such government spending in the western world, which avoids deficit spending to avoid inflation.

    Canada is lacking in domestic demand, a stronger currency would achieve this desired outcome.

    To help our manufactures we would have to eliminate the tax burrden on them, and regulations which directly run up the cost, to such a extent because they are currently disproportionatly impacted the most with a rising currency, making it justified.

    We need China to keep it factories open, not closed to the world, that would be a disaster, like the creditor exporting americans nation of the 1930’s.

    We do not need the US consumers, anyone can consume. There is a whole wide world of savers, that can consume sustainably, with stronger currencies.

    Wh would of thought the world, would return to growth without the US consumer. I did.

  • Andrew,

    You make a really good point about the likely shift in manufacturing taking place within the developing zone and not between the developing and developed zones.

  • I agree with Andrew that currency realignment is not going to fix the global current account imbalances.
    The Chinese are being made into scape goats. The U.S. over spend. Because they have a reserve currency, other nations hold onto to the excess dollars flowing out into the world economy as a result of the U.S. current account deficit. This has been going on since the 1970s. It led Europe to eventually adopt the Euro after years of exchange rate co-operation to keep fluctuations due to changes in the US dollar cross rates with their currencies to a minimum.
    Tired of benign neglect of the U.S. dollar outflow by the U.S. enough countries decided to peg to the U.S. dollar that the result was called Bretton Woods II because is amounted to a fixed exchange regime for much of the world. The Chinese are part of this. It allows them and all other participants to maintain stable cross rates for their currencies.
    The Milton Friedman system is everybody floats. Except everybody does not have a reserve currency.
    U.S. trade policy is not going to fix the situation caused by the almighty dollar. Neither is calling for everybody to float, which is what the U.S. wants. Paul Krugman lost it in an Oct. 21 blog post calling for the U.S. to impose countervailing duties on China if it does not float the Yuan up. Raise taxes in a recession! Does he not know what percent of Chinese exports are re-exports?
    Though he does not seem to understand it Krugman wants the Chinese to financialize their economy through exchange market liberalization. Then Wall St. can speculate to its hearts content on a rising Yuan, making super profits. The Japanese made this mistake in the 80s and are still paying for it today. The Chinese know this. I hope they have the courage to stick to their guns.
    The U.S. polity is seriously sick. Its never ending war policy, its catastrophic politics dominated by money, its inadequate social policy, and the financialization of its economy all need major attention.
    Paul Tulloch is right an industrial strategy is needed.
    I find it sad that the American “progressives” are not thinking in multilateral terms, a new world monetary order based on the SDR, a WTO committed to world employment goals, and serious re-distribution on a world scale.
    The situation being addressed by the G20 in Korea was created by the U.S. and no matter how hard they try to blame China most informed observers outside North America understand this.
    What kills me is to see to what extent the Canadian authorities continue to back the U.S. The good years under their domination ended in the mid-seventies.Where are the multilateralists?

  • One other issue- the QE2 will most likely push the dollar down, how far down? and how will the wake from such a monetary wave effect those not pegged.

    Oddly enough- Krugman knows full well state of the financial sector in the US and how rotten to the core it was and for the most part still is yet as you mention- he wants to part take in the blame game on China and monetary relaxation of controls as the means to solving the problems in China. It is precisely the thesis of his Return to Depression economics book that indeed it is these freeing of finance and the growth of the shadow banking that resulted in the meltdown, and now he wants China to head down the same pathway. Hmmm.

    Potentially he is the wrong source to look to for solutions. Undoubtedly we need a return to some sort of Bretton Woods 1 and fixed rates, but how to do this given the challenge of not having the culture of an base to build a new reserve currency is problematic.

    Will the end be a new global currency- I do think it is high time the world had such a debate and came to a consensus before the sky falls. (and while they are at it how about a financial transaction tax to help pay for the damages caused by the meltdown, and how about some new enforced labour and environmental standards. Potentially, it is a new deal at the global level that will stop the whirling dervish global economy.

    However do we have the institutions to accomplish that- G20 seems to be falling apart- IMF and World bank preaching austerity and obviously filled to the brim with the wrong sort of policy wonks.

    Purge the IMF and the world bank, get the G20 from this emergency state into a permanent replacement to the G8, establish a labour and environmental partners at the head of the global table and then I would say maybe, just maybe we would have a chance.

    But even the infrastructure is pretty flimsy at the global level to expect a pathway out towards solutions.

    Quite sad. I guess we did not learn enough from the last global mash up- although I do think we did, it is just the bias of wealth representation prevented the appropriate means to be developed for robust solutions.

  • Americans make so much fuss over Yuan’s exchange rate considering imports constitute only 18% of their economy and problems of elusive recoVery lie elsewhere.

    Often, the media and the US politicians take up the cause that pegged yuan is leading to the currency appreciation of other Asian countries. The response by these countries is that this whole argument needs to be looked at in a wider context of growth. There is a concern that drastic changes would impact growth.

  • It looks like I am going to be the only one arguing that trade imbalances are or not the result of unilateral decisions. Yes currency values matter. Along with other ways in which trade is distorted. While many may point out that a change in the Yuan will just shift the trade deficit to other low cost producers, misses to important points. Number one, many of the countries that might be the recipients of such a shift also control their currencies, to remain competitive with China. If China allows the RMB to rise, they will follow. Secondly China’s trade advantage has more to do with cheap capital, and lax regulations, and other subsidies than labor costs.

    If currency values do not effect trade balances and employment then why is China, Long on USD and Short on the RMB? Talk about contrarian investing! Why doesn’t Japan, with at debt of 200% of GDP, liquidate some the their USD holdings. They can’t with out reversing the the effect they had in previously undervaluing their currency.

    IMHO, this is required reading…..

    “The point is that sarcastic comments about predatory American consumers forcing dim-witted Chinese households to save more and consume less, or predatory Chinese savers forcing helpless American households to borrow and consume, may be good debating tactics but they are misleading and explain nothing. At the macro level either event – higher Asian savings leading to higher American consumption, or higher American consumption leading to higher Asian savings, or even a combination of the two – is perfectly possible.

    So why should we accept the Asian savings glut hypothesis? One argument that I first saw proposed by Brad Setser was that if the imbalances had been driven by US consumption, and therefore US borrowing needs, the consequence should have been an increase in US interest rates. Had they been driven by excess savings, US borrowing rates would have probably declined.

    In fact during most of the relevant period US interest rates did decline, even leading to the US Fed several times complaining about its inability to control domestic long-term rates.”

  • Again, call me paranoid, but are we not on the verge of seeing the Canadian dollar burst through parity and reach into the 1.10-1.20 marks with the coming QE2?

    With the coming gridlock of the US politics, meaning do nothing on the economy- until Obama and the Dems are thrown from office, the last substantive efforts is the QE2.

    Will the ability of the US as a reserve currency maintain the privilege to print whatever it wants, or will some kind of global reality (a broken global monetary system) finally set it and set the dollar in a spiral downward? For Canadians in resource sectors it will be a boon and your can be assured the oil industry will love Mr. Harper even more. But we could see a whole new round of manufacturing and services jobs disappear. Are we ready to sacrifice the remaining non-resource based part of our economy? We are on the cusp and you can feel it within your economic stomachs- at least I can, as I am feeling quite queasy these days.


  • To further my point about capital, not currencies or labour costs being more relevant to trade imbalances I point to Paul Otellini (CEO of Intel) recent comments…….

    “It costs Intel $1 billion more to build a factory in the United States than it does in China — and it is not because of cheap labor. Ninety percent of the difference comes from the Chinese government providing Intel with capital grants, equipment grants, tax holidays and incentives. ”

    Otellini says that almost all of Intel’s primary competitors are in Asia and that they are provided with substantial leverage over American companies. “In the case of Samsung, which is a large competitor of ours, Korea basically [provides it with] zero taxes and free money,” says Otellini. “You have people that work in standards that would not be acceptable to American workers. They have a different level of productivity. It’s not something I aspire to, I just say that’s a difference. They can get more out per nickel, so you have to watch that.”

    While I agree with his opinion that these distortions are effecting decisions in where to manufacture, I disagree with his suggestions to correct it.

    Basically he suggest the the US should match them. I prefer that they account for them in tariffs, to the point that not only do they cover the the difference in subsidy but also account for the lost potential domestic producers incur in procuring exports.

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