Page 1 of 3 China plays by its own currency rules
By Peter Lee
The past two years have been tough on China-oriented Western economists.
China's archaic mercantilism, tight capital controls, over-regulated financial
sector, managed exchange rate and, above all, its need to purchase and
sterilize massive inflows of foreign exchange were, according the theorists,
leading the country to economic calamity.
However, Western triumphalism in 2008 took a tumble as the West's most
sophisticated financial innovators led the world economy off a cliff.
Meanwhile, China's ham-fisted socialists saved China and, to a certain extent,
the rest of the world with an enormous stimulus program (US$586 billion in
domestic spending plus significantly relaxed limits on bank lending) that, as a
the gross domestic products (GDP), dwarfed America's stimulus spending by a
factor of more than five.
Pro-Western economists and advocates of sophisticated, US-style financial
engineering took a hit inside China as well.
An important, but little-noted milestone was passed last week in Washington:
the Reserve Primary Fund, a supposedly safe-as-houses $62 billion money market
fund that went bust when Lehman Brothers imploded in November 2008, finally
finished paying off its investors.
Its biggest creditor - China's sovereign wealth fund, China Investment Corp
(CIC) (which had earned creditor status because it sent in a last-minute
redemption order for its $5 billion-plus stake just before the fund closed) -
was paid off in multiple installments totaling about 98.75 cents to the dollar.
However, in 2008 the incident sparked off a heated debate in Beijing concerning
the wisdom of trying to ingratiate China to the United States by positioning
itself as an eager participant in the Wall Street casino organized by
politically powerful financial firms.
As the Wall Street Journal reported at the time, the Chinese leadership was
appalled to discover it held $600 billion in Fannie Mae and Freddie Mac bonds
just as these two government agencies were tottering near extinction, as well
as the sizable stake in the Reserve Primary Fund:
Around October, a
lengthy Chinese-language essay began circulating on the Internet excoriating
[chairman and chief executive] Mr Lou [Jiwei] and other top CIC officials,
along with Zhou Xiaochuan, China's central bank governor, for being too close
to the US and then-Treasury secretary Henry Paulson. The diatribe quickly
gained wide circulation in Chinese financial circles. One passage charged that
Mr Zhou "colluded with Henry Paulson to buy US bonds, forced [Chinese yuan]
appreciation, attached China's economy to the US and broke China's economic
At times like this, it's instructive to
recall that economics is not a hard science, and the fact that 70% of
recipients of the Nobel Prize in Economics are Americans is no guarantee of US
omniscience on the subject. For that matter, the Nobel Prize in economics is
not a real Nobel prize, owing its existence to the marketing and cross-branding
savvy of the Sveriges Riksbank rather than any desire by Alfred Nobel to
celebrate what is often called "the dismal science". 
Two years after Lehman fell, vociferous debate continues between economists of
various ideological stripes about what caused the Great Recession, despite the
fact that it occurred under their very noses.
The role and responsibilities of the rather non-transparent Chinese economy
have proved an even more intractable conundrum. The only conclusion that
everyone can agree on is the simple fact that the Chinese currency is
undervalued and, as such, offers an unfair advantage to Chinese exporters. No
one, however, seems to agree on what can and should be done about it.
Now, it appears that many economists have given up on waiting for the invisible
hand to correct the yuan exchange rate and, if possible, rebalance the global
economy. Instead, it's time for the mailed fist of government policy - the
command economy, if one will - to try to obtain what market forces have failed
There is widespread dispute over the degree of undervaluation, and what degree
of appreciation would be most desirable for the world economy. There are
growing calls for a multilateral confrontation with China to force Beijing to
appreciate the yen by 25% or more - which, it is calculated, would leave China
enjoying a trade surplus of 3% - or eliminate the surplus with an increase of
40% or more.
But disregarding the forces at play in China's economy - and in the
calculations of the country's leaders - offers the prospect of conflict without
American frustrations were given a full airing at the September 15 hearings of
the US House of Representatives' ways and means committee. Leo Girard,
president of United Steelworkers Union and Dan DiMicco, president of Nucor
Corporation - Nucor made its fortune in the 1980s by ripping the heart out of
America's integrated, unionized steel mills with its low-cost mini-mills that
ran on scrapped cars - made for unlikely allies in condemning the massive job
losses attributed to China's artificially low exchange rate.
Predictably, US farm-state senators also appeared before the committee to make
the case for avoiding the trade war and sustaining the grain exports to China
that underpin the economies of the American heartland.
But the most arresting testimony was provided by G Paul Bergsten, founder and
president of the Petersen Institute. Over the years, Dr Bergsten and the
Petersen Institute have attempted to claim the exchange rate/Chinese currency
wonk franchise through thousands of pages of closely argued publications,
testimony, and op-eds.
However, Bergsten has apparently abandoned economic theory and win-win suasion
in favor of big-stick tactics to compel a Chinese revaluation. He proposed a
multilateral effort justified and executed under the regulations of the World
Trade Organization (WTO):
A general indictment of China under Article XV, which proscribes countries from
"frustrating the intent of the provisions of this Agreement by exchange
action", prosecution under which would authorize members to retaliate against
Approval of case-by-action action by individual countries that chose to regard
China's currency undervaluation as an export subsidy under the Code on
Subsidies and Countervailing Duties, which China would have to challenge to
The key coercive measure would be the
legally questionable tactic of imposing countervailing duties as retaliation
for currency manipulation; its virtue would be that the United States and other
countries could impose the duties unilaterally, and place the onus on China to
go before the WTO to challenge and overturn them.
In return, Bergsten promised the US Congress in his oral testimony a gusher of
500,000 new US jobs (retreating to a more scholarly and cautious range of
300,000 in his written testimony) if China responded to this "shot across the
bow" by revaluing its currency to eliminate its trade surplus with the US.
Bergsten's questionable powers of prediction - he had gained a certain amount
of notoriety at Davos in January 2008 when he asserted that "a global recession
was inconceivable" - were challenged by the Council for US-China Trade's John
Frisbie glumly pointed out that a hefty US countervailing duty on Chinese
automobile tires had, instead of yielding a bonanza for American employment,
simply redirected imports away from China to other overseas suppliers:
imports from China are down 26%; imports from Japan, South Korea, Taiwan,
Indonesia, Thailand and Mexico have more than filled the void and imports of
low-end tires overall are 21% higher than before the tariffs. 
On the theoretical level, the idea that exchange rate adjustments are a panacea
for national trade and investment problems has been rebutted by Ronald
MacKinnon of Stanford University. 
Unfortunately, what lies behind
this unnecessary political crisis is a widely held but false economic belief:
the idea that the exchange rate can be used to control any country's trade
balance, which is the difference between its saving and investment rate.
Instead, the problem is a saving deficiency in the US - with very large fiscal
deficits and low personal saving - coupled with surplus saving in China.
Nevertheless, a common thread running through the testimony was a renewed
appreciation for what might be turned the meat-ax approach to exchange-rate
management symbolized by the 1985 Plaza Accord.
In the opinion of its advocates, the Plaza Accord seems to have been the last
thing that worked the way it was supposed to in US exchange rate policy. As
Asia Times Online readers know, it has emerged as a perennial in the US-China
trade debate. 
In the 1980s, Japan posed problems that current critics of China will easily
recognize: it was an export machine, accumulating huge surpluses, gutting the
US auto industry with surging sales of Toyotas, Nissans and Hondas, and hiding
behind capital controls and a yen/US$ exchange rate pegged as low as