By: Mr.Fog on Venerdì 11 Febbraio 2005 22:21
John M. Berry is a columnist for Bloomberg News. The opinions expressed are his own.
Fed Officials Don't See China Dropping Peg Soon: John M. Berry Listen
Feb. 11 (Bloomberg) -- Federal Reserve officials aren't optimistic that China will drop its currency peg against the dollar anytime soon because that decision is in the hands of a State Council focused primarily on political stability rather than financial issues.
The State Council apparently believes that China's political stability hinges on continued strong economic growth that will provide the tens of millions of new jobs needed by workers moving out of agriculture and into the industrial economy. And that growth in turn is seen as dependent on keeping the yuan pegged tightly to the dollar.
Fed Chairman Alan Greenspan has said that keeping the yuan pegged to the dollar means that the People's Bank of China, the country's central bank, can't control the nation's money supply. As a result, mounting inflationary pressures eventually will force a revaluation of the yuan, he has said.
At the same time, keeping the peg has forced the central bank to accumulate well over half a trillion dollars worth of foreign exchange reserves, mostly U.S. dollars.
And the exploding U.S. trade deficit with China is generating increasing protectionist pressure in this country. The Commerce Department said yesterday that the trade deficit with China was $162 billion last year. That's more than double the $75 billion deficit with Japan or the $72 billion deficit with the members of the Organization of Petroleum Exporting Countries.
Two Risks
China's central bank officials are acutely aware of all these issues. In a sense, though, they are advisers to the decision makers on the State Council, a political body, and that leaves the timetable up in the air for any easing of the dollar peg. That worries some at the Fed.
In a speech in Washington on Feb. 9, Timothy F. Geithner, president of the New York Federal Reserve Bank, cited two major risks to world economic growth. One is the increasing government debt-to-GDP ratios in most of the major economies.
``At the same time,'' Geithner said, ``external imbalances have reached unprecedented levels, most dramatically in the case of the U.S. current account deficit, which is on a path to exceed 6 percent of GDP. These imbalances -- fiscal and external -- cannot be sustained indefinitely. Each magnifies the risk in the other.''
Addressing the external imbalances, he said, requires ``a necessary evolution in the global exchange rate system.''
`Future Stress'
``The present system, where the major currencies adjust against each other, but many large emerging market economies tie their currencies to the dollar or shadow it closely, creates an awkward asymmetry.
``This system carries with it the seeds of future stress for the global economy,'' Geithner warned.
At a symposium at the San Francisco Federal Reserve Bank last week, more than 30 economists, mostly from universities and international institutions, tackled the issue of China's currency peg. Most of them argued that the Chinese would be forced to adopt a more flexible exchange rate regime, and some said that would come no later than next year.
On the other hand, the symposium -- which was titled, ``The Revived Bretton Woods System; A New Paradigm for Asian Development?'' -- was called to discuss a series of papers by economists who maintain that the Chinese have such an overriding interest in strong growth that the peg will last at least for another five years.
How Long the Peg?
Economist Peter Garber, global strategist for Deutsche Bank, one of the papers' authors, told the group, ``I don't think anybody disagrees that this eventually will come to an end.'' That probably will only happen ``when the labor supply is absorbed,'' he said.
One of his co-authors, Michael Dooley of the University of California, Santa Cruz, said the peg will last ``five years, or you could go a little further.''
The heart of the Dooley and Garber analysis, in which David Folkerts-Landau, another Deutsche Bank economist, has participated, is that the current situation in China and other East Asian nations resembles that of Western Europe in the 1950s after much of it was devastated by World War II.
Under the aegis of the Bretton Woods system of exchange rates fixed to the dollar, they said, the European nations enjoyed the trade advantages of undervalued exchange rates that allowed them to rebuild their stocks of productive capital. The authors described the U.S. as being the ``center'' of that system and Europe on the ``periphery.''
Paying the Price
Today, the U.S. is again the ``center'' with China and other East Asian countries on the ``periphery,'' in their view. In a National Bureau of Economic Research Working Paper published last July, ``Direct Investment, Rising Real Wages and the Absorption of Excess Labor in the Periphery,'' they wrote:
``If the price to be paid for this (industrialization) strategy includes financing a large U.S. current account deficit, governments in the periphery will see it in their interest to provide financing even in circumstances where private international investors would not.
``The catastrophic losses and abrupt price breaks forecast by the conventional wisdom of international macroeconomics arise from a model of very naive government behavior. In that model, periphery governments stubbornly maintain a distorted exchange rate until it is overwhelmed by speculative capital flows. In our view a more sensible political economy guides governments in Asia. The objectives are the rapid mobilization of underemployed Asian labor and the accumulation of a capital stock that will remain efficient even after the system ends.''
Peg `Will Unravel'
According to Dooley and Garber, China is following a wholly different development path than most underdeveloped nations have tried. China has such a high savings rate -- 40 percent or more of GDP -- that capital is being ``pushed into the United States'' to finance a large portion of the U.S. current account deficit.
No one at the symposium expressed support for the notion that the Chinese would be able to maintain their peg nearly as long as Dooley and Garber said they could. Nouriel Roubini of New York University was the most vociferous among those attacking Dooley and Garber's view.
``It's not sustainable and will unravel,'' Roubini said. ``Once central banks signal less willingness to finance,'' that will trigger a massive private investor rush out of the dollar.
Edwin M. (Ted) Truman, a senior fellow at the Institute for International Economics and former head of the Fed Board's Division of International Finance, referred to the papers as ``musings'' and said their ``view is incorrect and their framework does not provide a useful guide for analysis or policy.''
An Alternative
``A continuation of a U.S. current account deficit of 6 percent of GDP is neither economically, financially nor politically sustainable,'' Truman said. ``The large economies with more or less firm pegs to the dollar inevitably will have to be part of the adjustment process.''
Other attendees noted that even if Dooley and Garber had correctly described the new system, it is breaking down. Several other nations assumed to be part of the periphery, including Korea, Thailand, Singapore and Taiwan, have all allowed their currencies to appreciate against the dollar beginning last fall.
Ronald McKinnon of Stanford University challenged Dooley and Garber, and most of their critics as well, with an intriguing proposition.
``Exchange rate changes are not the answer to American trade deficits and Asian trade surpluses,'' McKinnon said. Instead, China should keep its peg and let the long run international adjustment occur by allowing its wages to rise in line with its extremely high productivity growth. That process, he added, is already happening.
