China’s Fair-Weather American Friends

Hans-Werner Sinn
Project Syndicate, October 2010; also published by Börsen Zeitung, 26.10.2010, No. 206, p. 6.

MUNICH – Because China has pegged its undervalued currency, the renminbi, to the dollar, every weakening of the dollar in the wake of America’s financial crisis has also meant a weakening of the renminbi vis-à-vis other world currencies. But is China really to blame for the eruption of a global currency war?

The central banks of South Korea, Brazil, Taiwan, Japan, Switzerland, and many other countries are now buying dollars in order to protect their own currencies against revaluation and thus to defend their exports. Europe also became nervous after the euro exchange rate rose to more than $1.40, far beyond the purchasing power parity (PPP) rate of $1.17.

The United States is now taking drastic steps against China, and is making provisions for a trade war. Congress has authorized the President to impose import duties on Chinese products if China remains unwilling to increase the value of its currency substantially against the dollar.

But the undervaluation of the renminbi, which is currently 45%, has persisted for many years. So why is the US suddenly acting so aggressively? Why didn’t America take action much earlier?

The reason lies in capital movements. The US accepted the lower valuation of the renminbi as long as China returned the dollars that it earned from bilateral merchandise trade by financing America’s budget deficit. Now that the Chinese prefer to invest that money in raw materials in Africa and elsewhere, they have aroused the full ire of American policymakers.

China’s shift has been dramatic. In 2008 and 2009, the Chinese purchased US government bonds at a rate of $17 billion a month. But China reversed course in November 2009. During the first seven months of 2010, China not only refrained from buying any more US government paper, but even began to sell its holdings. Each month, China sold a net sum of about $7 billion in US government bonds. That nerves are now on end in America is perfectly understandable.

The City of London has jumped into the breach, increasing its purchases, which in 2008 and 2009 amounted to only about $1 billion monthly, to an average of $28 billion in the first seven months of this year. Since the United Kingdom itself is a large capital importer, we can assume that the City is not holding the paper itself but merely restructuring it and then selling it to the world under a new name and with the London stamp on it.

Despite its withdrawal from financing the US government, China remains the world’s largest net capital exporter, a position that it has held since 2006.In2007 and 2008, China exported on average about $400 billion of capital annually. The US, which at the time needed annual capital imports of $800 billion in order to offset the near total cessation of private savings, received the lion’s share of this capital. The unwillingness of the Chinese to consume enabled Americans to build new houses for many years on borrowed money and to maintain a level of consumption that the US economy was unable to finance on its own.

To be sure, the Chinese always restrained themselves from private real-estate financing in the US. They bought only government paper and securitized real-estate instruments that were issued by the semi-public bodies Fannie Mae and Freddie Mac. Direct real-estate finance via private channels came mainly from other countries – Germany, for example. Nevertheless, China helped the US to achieve a higher standard of living by making money available to government authorities that would otherwise have had to come from American taxpayers.

Given this history, it is a bit shabby to reproach China now for its exchange-rate policy – a policy that enabled the US to live beyond its means for so long. Rather than coming at the expense of the US, as is constantly claimed, it was the renminbi’s low valuation that allowed Americans to dream their American dream of universal homeownership. Imports of inexpensive Chinese products freed up capital and labor in the US for a dramatic expansion of the housing stock – which led to a sharp rise in the American standard of living.

It is understandable that the Chinese are now reluctant to invest more money in the US. They tried to enter the US energy market with the purchase of Unocal, but were blocked by politicians. Other direct investments were also stopped by Congress on the pretext of national security.

One need only recall the bidding for Emcore or Firstgold. The US wanted the Chinese money, but it was not prepared to offer anything more than structured securities of questionable creditworthiness, as well as government paper that is now clearly exposed to the risk of inflation and devaluation.

It would be a service to world peace if the US stopped making cheap moral accusations against China. The truth is much more subtle than naked political interest.