Tuesday, 19 May 2009

Krugman Does China

Couldn't resist letting Paul Krugman's China trip slip by without comment, especially since I just moved out of Hong Kong after three years. I found this article by China Stakes (Krugman in China: Stimulating, Controversial, and Expensive) to be amusing.

It appears the Chinese were initially delighted to have Krugman on the Sino-lecture circuit for several reasons. First, he is seen as an economic prophet (and what price can you put on one of those -- oops, looks like $200,000 an appearance, according to the article, making this probably a million-dollar jaunt for PK). He also won the Nobel Prize recently and has been a harsh critic of the U.S. response to the financial crisis.

Everything seemed to be in the cards for a lovely week of high-powered talks and shmooze-fests. You can almost see the dark-suited Chinese officials sitting in the front row and nodding with vigor as Krugman lambastes the Obama team's tepid response to the banking mess. "Why, oh why, are they so frightened of nationalization?" Krugman thunders as an audible murmur of sympathy rises from the audience.

But of course, the trouble with mavericks and independent thinkers is they don't heel and sit up and roll over on command. The article made Krugman sound a bit prickly as he challenged China to take responsibility for the impact of its own huge and persistent trade surpluses. He spoke frankly about the root cause of the surpluses, the country's currency regime.

That part greatly interested me. In Hong Kong, studying China's exchange rate policy became one of my pet projects. I became convinced it was the keyhole to understanding the country's larger economy.

This is what Krugman had to say on the subject, according to the article:
Krugman also hinted that China's massive trade surplus is the result of manipulating its currency's exchange rate. He said: “The U.S. Congress will review China's currency each year, and the Treasury will report whether some countries are manipulating currency or not. The answer each time is that China doesn't manipulate, but everybody knows this is not an honest assessment, it's a decision made to avoid conflicts.”

Does China manipulate the rate at which the renminbi (or yuan) trades against the currencies of other nations? Absolutely. I know China fumes and stamps its feet whenever the U.S. hints at this, but that's all theater.

Don't be fooled by that move back in the summer of 2005. Remember? China switched to an exchange rate that floated against a basket of currencies, within a narrow band (that itself is periodically adjusted). It sounds like they freed up their currency somewhat.

Not really. Theater, all theater.

The Chinese made the change, cleverly, to outfox their opponents in the U.S. who complained about the country's fixed rate policy that undervalued the yuan. The Chinese stood accused of dumping low-cost goods and stoking their economy through exports. Beijing answered with a "managed currency" that would "float." Of course it floats in the same way that a dog on a four-inch leash runs.

Actually it's even worse. The semblance of a sort of-floating currency gives the Chinese cover to monkey around with the exchange rate as they wish. While living in Hong Kong, I noticed sometimes it moves opposite the way news would indicate, as the Chinese tweak it down or up to try to discourage currency speculators.

The best evidence that the "basket of currencies peg" is a fiction appears in Jonathan Anderson's wonderful look at the currency, "The RMB Handbook." A graph shows the RMB, after the peg, making a slow but steady increase against the dollar for the next year or so. Anderson, a UBS economist, found that the slow, linear creep of the RMB versus the dollar couldn't be mathematically explained, no matter how creatively you composed that basket of currencies. It was too precise, lacking normal volatility. It was ...

Manipulated (my language, not his). Totally. Indeed you can reasonably draw no other conclusion (note: for semantic reasons, you may prefer the word "managed" to "manipulated" -- I know that James Fallows of the Atlantic, an excellent observer of the China scene, doesn't like the emotional freight carried by "manipulated.")

I'd be the first to say, "Of course China manipulates its currency." But I'd argue that's usually a good thing. Essentially they're selling us stuff for 20, 30 percent off (or however much the currency is undervalued). If Macy's has a clearance sale, do you go outside the store and picket in protest? Hell no. You limber up your wallet and get a parking spot early. Of course the trouble is there's a dark side to this, as we're seeing now. Our unrestrained consumerism in the U.S. coupled with bad policy led to huge trade imbalances that cause global stress.

If I'm scoring this, I place most of the blame with the United States for not recognizing the implications of the undervalued currency and not reacting accordingly. Even if someone offers you all the half-price donuts you want, you don't have to eat yourself into a stupor. But China, as Krugman observes, doesn't escape scot free. They were complicit. They need to make changes too.