Page 4 of 4 CHINA'S DOLLAR MILLSTONE, Part 1 Breaking free from dollar hegemony
By Henry C K Liu
supporting domestic development, which should be the main focus of economic
growth. The domestic sector should no longer be made to sacrifice to support
the export sector. Exports should support domestic development, not act as a
parasite on domestic development.
Breaking free from dollar hegemony
A first step in this redirection of policy focus on domestic development is for
China to free itself from dollar hegemony. This can be done by legally
requiring payment of all Chinese exports to be denominated in yuan to stop the
unproductive role of exporting for dollars that cannot be spent domestically
without incurring
heavy monetary penalty. Such a policy affects only Chinese exporters and can be
implemented unilaterally by Chinese law as a sovereign nation, without any need
for international coordination or foreign or supranational approval.
Importers of Chinese goods around the world will then have to acquire yuan from
the Chinese State Administration for Foreign Exchange (SAFE) to pay for imports
from China. The yuan exchange rate and Chinese export prices can then be
coordinated according to Chinese domestic conditions. Import prices denominated
in yuan can then be more rationally linked to Chinese export prices. Foreign
trade for China then will benefit the yuan economy rather than the dollar
economy. There will be no need for the PBoC to hold dollar reserves.
China's economic growth since 1980 has been driven by export of low-price
manufactured goods with a dysfunctionally low wage scale. To correct the
imbalance of trade that has been giving China trade surpluses of dubious
financial or economic benefit, China needs to raise wages, not to revalue its
currency. Raising Chinese wages to the level of other advanced economies will
redress the current inoperative terms of international trade that now benefits
only the dollar economy to benefit the Chinese yuan economy.
This low-wage-driven growth has distorted the progressive purpose of Chinese
socialist society by reintroducing many of the pre-revolution socio-economic
defects commonly found under market capitalism, such as income and wealth
disparity, market-induced chronic unemployment, inequality of opportunities,
collapsed social safety nets resulting from privatization of the part of the
economy best handled by the public sector, rampant corruption from a collapse
of societal morals and excessive influence of money in the political process,
uneven regional development and environmental deterioration of crisis
proportions.
The current export-led growth of China can be expected to be seriously hampered
by a protracted slowdown in the importing economies. Despite China's image as
an export juggernaut, the country's per capita merchandise export in 2006 was
$1,655, some $135 lower than global per capita merchandise export of $1,780.
This is because Chinese wages are substantially lower than the average of all
export economies, while the prices of raw material are the same for all buyers
in the global market.
A fall in world demand for exports would hit China harder than other export
economies by pushing already too low Chinese wages further down just to keep
Chinese export factories running. Also, since China's trade dependency has
increased steadily over time, importing inflation through the export sector to
the domestic sector, China's economy would be hit proportionally harder by a
downturn in exports than it was during previous global recessions, unless
current policy to reduce trade dependency is accelerated.
Exports are measured by gross revenue while GDP is measured in value-added
terms. The rules of input-output macroeconomics requires import inputs to be
subtracted from exports in value-added terms, and then conversion of the
remaining domestic content into value-added terms by subtracting inputs from
other domestic sectors to avoid making the denominator for the export ratio
much bigger than GDP. Normally, this would reduce the export-to-GDP ratio. But
China's domestic input is excessively low due to low wages and rents, tax
subsidies and weak environmental regulations. Thus such input adjustments have
little impact on the trade-to-GDP ratio.
In recent years, China has been shifting from exports with a high domestic
content, such as toys, to new export sectors that use more imported components,
such as steel and electronics, which accounted for 42% of total manufactured
exports in 2006, up from 18% in 1995. Domestic content of electronics is only a
third to a half that of traditional light-manufacturing sectors. So in
value-added terms, exports have increased less than gross export revenues. This
is not a comforting development because it turns the export sector into a
re-export sector, benefiting the domestic economy even less.
China's current-account surplus amounted to 11% of GDP in 2007. This means its
entire GDP growth was from the export sector, and its economy produced far more
than it consumed domestically. This surplus production was shipped overseas for
fiat dollars that cannot be spent in the yuan economy while Chinese workers
could not afford the very products they produced at low wages. Thus under
hegemony, while China has become the world's biggest creditor nation, it
suffers from shortage of capital needed by its still undeveloped economy,
particularly in the vast interior, and has to depend on foreign capital even in
the coastal regions when the export section is located. In recent years,
Chinese policy has encouraged higher domestic consumption, yet since 2005, net
exports have contributed more than 20% of GDP growth.
Some analysts have suggested that China's GDP growth would stay at 9% from
strong domestic demand. Yet this demand comes mostly from severe income
disparity. China's exports to other emerging economies are now bigger than
those to the US or the EU. Asia and the Middle East accounted for more than 40%
of China's export growth in 2007, North America for less than 10%. But Chinese
trade with other emerging economies was at a deficit, with China importing
more, such as oil and other commodities, than the oil-exporting small economies
could absorb in the way of low-price Chinese goods for their small populations,
while poor emerging economies cannot buy more from China because they do not
have sufficient dollars. If Chinese exports are denominated in yuan, trade with
these poor economies would explode with balance because their exports to China
can also be denominated in yuan to pay for imports from China denominated in
yuan.
Export for dollars presents for all exporting countries a problem of
diminishing returns because of dollar hegemony. For China, it is a problem of
crisis proportions. Since global trade is denominated in dollars, China's
economy faces a capital shortage despite its new role as the world's biggest
creditor nation. China is forced to accept foreign direct investment, which
accounts for over 40% of GDP, despite the country's chronic trade surplus and
huge foreign exchange reserves of upwards of $1.8 trillion and growing. Weaker
export growth could lead to a sharp drop in foreign direct investment because
exporters would need to add less capacity.
While over half of all foreign direct investment in China is in infrastructure
and property, such investment is still mostly related to exports, facilitating
expatriate managers' housing, foreign company offices in commercial buildings,
power plants to supply export factories and highways linking production areas
with shipping terminals. Only sovereign credit can redress China's problem of
uneven regional development caused by excessive dependence on foreign
investment.
Next: Developing China's economy with sovereign credit
Henry C K Liu is chairman of a New York-based private investment group.
His website is at http://www.henryckliu.com.
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