February 25, 2010, 8:25 am
Time to Press China on Its Exchange Rate
By SIMON JOHNSON
DESCRIPTIONSean Yong/Reuters
Today's Economist
This morning the bipartisan United States-China Economic and Security Review Commission holds a hearing on “U.S. Debt to China: Implications and Repercussions.” I’m on the first panel, which will discuss in part the perception that China’s large dollar holdings confer upon that country some economic or political power vis-à-vis the United States. In particular, I’ll talk about whether Chinese reserves prevent us from putting pressure on that country’s authorities to revalue (i.e., appreciate) the renminbi.
I will argue that this view is incorrect and completely misunderstands the situation. Here’s the outline of my reasoning.
The exact amount of China’s foreign-exchange reserves is not knowable based on publicly available information. But a reasonable working assumption is that China owns close to $1 trillion of United States Treasury securities. That would be nearly half of the stock of Treasuries thought to be in the hands of “foreign official” owners, which was $2.374 trillion at the end of 2009, and just under one-seventh of all American government securities outstanding ($7.27 trillion, of which $3.614 trillion was held by all foreign owners, official and private, at the end of 2009).
China holds such large reserves because it intervenes to buy dollars in order hold down the value of its currency, the renminbi. It is in the interests of both the United States and global economic prosperity that China allows its currency to appreciate. Foreign-exchange market intervention on this scale is a breach of China’s international commitments (as a member of the International Monetary Fund) and constitutes a form of unfair trade practice.
If China were to end its intervention, the renminbi would appreciate substantially, likely in the region of 20 to 40 percent. The primary effect would therefore be an effective depreciation of the American dollar against the Chinese renminbi – and against all other countries’ currencies that are implicitly pegged to the renminbi (more precisely, to the dollar rate with an eye on China’s competitiveness).
Such a change in the value of the dollar would help expand our exports and improve our ability to compete against imports; this would aid in the process of recovery, job creation and broader adjustment in the American economy.
Even a substantial movement in the dollar – e.g., a 20 percent deprecation in real effective terms, which is most unlikely – would have no noticeable effect on inflation and therefore would not force the Federal Reserve to increase interest rates. The “hard landing” scenario for the dollar – feared by analysts since the traumatic experiences of the 1970s – is unlikely for the United States today, given the low level of inflation expectations and the high gap between where the economy is today and where it has the potential to be. (That gap is reflected in measured unemployment near 10 percent and true unemployment — which would include people who have given up looking for jobs — of at least 15 percent).
The effect on short-term United States interest rates would therefore probably be minimal or nonexistent, particularly as the Federal Reserve currently aims to keep rates close to zero. The effect on longer-term interest rates would also be small – and could be offset by the Federal Reserve, as it currently seeks to limit all benchmark interest rates (most recently affirmed by the Fed chairman, Ben S. Bernanke, this week).
In fact, the current stance of monetary policy – and the low, stable level of inflation expectations in the United States – makes this an ideal moment at which to press China to revalue its currency.
In another potential scenario, there is concern that China would threaten to reduce its purchases of United States government securities. But if China continues to intervene, it will accumulate foreign reserves, so it needs to hold increasing amounts of foreign assets of some kind. What else would the Chinese authorities buy?
1. If they buy other dollar-denominated assets issued by American entities, this would push down spreads on those assets relative to Treasuries. This would directly help private American borrowers – thus stimulating growth in the United States.
2. If they directly buy dollar-denominated assets issued by non-American entities, this will still reduce spreads more broadly and help American borrowers – as there is a global market for dollar assets and there is not much high grade non-American dollar debt available for sale.
3. If they buy dollar equities – which is most unlikely – this would help the stock market, household balance sheets and firms’ access to funding (as well as helping to shift our economy from debt to more equity financing, which would a desirable move in any case).
4. If they buy non-dollar assets, given that the Fed will keep interest rates near to zero, this will push down the value of the American dollar and help boost America’s economic growth. Such a move would produce protests from the euro zone and Japan, but this change in currency value would be solely China’s responsibility.
If China stops buying foreign assets altogether, this would of course be equivalent to ending foreign-exchange intervention. This is exactly the policy change that we should be seeking.
Time to Press China on Its Exchange Rate
By SIMON JOHNSON
DESCRIPTIONSean Yong/Reuters
Today's Economist
This morning the bipartisan United States-China Economic and Security Review Commission holds a hearing on “U.S. Debt to China: Implications and Repercussions.” I’m on the first panel, which will discuss in part the perception that China’s large dollar holdings confer upon that country some economic or political power vis-à-vis the United States. In particular, I’ll talk about whether Chinese reserves prevent us from putting pressure on that country’s authorities to revalue (i.e., appreciate) the renminbi.
I will argue that this view is incorrect and completely misunderstands the situation. Here’s the outline of my reasoning.
The exact amount of China’s foreign-exchange reserves is not knowable based on publicly available information. But a reasonable working assumption is that China owns close to $1 trillion of United States Treasury securities. That would be nearly half of the stock of Treasuries thought to be in the hands of “foreign official” owners, which was $2.374 trillion at the end of 2009, and just under one-seventh of all American government securities outstanding ($7.27 trillion, of which $3.614 trillion was held by all foreign owners, official and private, at the end of 2009).
China holds such large reserves because it intervenes to buy dollars in order hold down the value of its currency, the renminbi. It is in the interests of both the United States and global economic prosperity that China allows its currency to appreciate. Foreign-exchange market intervention on this scale is a breach of China’s international commitments (as a member of the International Monetary Fund) and constitutes a form of unfair trade practice.
If China were to end its intervention, the renminbi would appreciate substantially, likely in the region of 20 to 40 percent. The primary effect would therefore be an effective depreciation of the American dollar against the Chinese renminbi – and against all other countries’ currencies that are implicitly pegged to the renminbi (more precisely, to the dollar rate with an eye on China’s competitiveness).
Such a change in the value of the dollar would help expand our exports and improve our ability to compete against imports; this would aid in the process of recovery, job creation and broader adjustment in the American economy.
Even a substantial movement in the dollar – e.g., a 20 percent deprecation in real effective terms, which is most unlikely – would have no noticeable effect on inflation and therefore would not force the Federal Reserve to increase interest rates. The “hard landing” scenario for the dollar – feared by analysts since the traumatic experiences of the 1970s – is unlikely for the United States today, given the low level of inflation expectations and the high gap between where the economy is today and where it has the potential to be. (That gap is reflected in measured unemployment near 10 percent and true unemployment — which would include people who have given up looking for jobs — of at least 15 percent).
The effect on short-term United States interest rates would therefore probably be minimal or nonexistent, particularly as the Federal Reserve currently aims to keep rates close to zero. The effect on longer-term interest rates would also be small – and could be offset by the Federal Reserve, as it currently seeks to limit all benchmark interest rates (most recently affirmed by the Fed chairman, Ben S. Bernanke, this week).
In fact, the current stance of monetary policy – and the low, stable level of inflation expectations in the United States – makes this an ideal moment at which to press China to revalue its currency.
In another potential scenario, there is concern that China would threaten to reduce its purchases of United States government securities. But if China continues to intervene, it will accumulate foreign reserves, so it needs to hold increasing amounts of foreign assets of some kind. What else would the Chinese authorities buy?
1. If they buy other dollar-denominated assets issued by American entities, this would push down spreads on those assets relative to Treasuries. This would directly help private American borrowers – thus stimulating growth in the United States.
2. If they directly buy dollar-denominated assets issued by non-American entities, this will still reduce spreads more broadly and help American borrowers – as there is a global market for dollar assets and there is not much high grade non-American dollar debt available for sale.
3. If they buy dollar equities – which is most unlikely – this would help the stock market, household balance sheets and firms’ access to funding (as well as helping to shift our economy from debt to more equity financing, which would a desirable move in any case).
4. If they buy non-dollar assets, given that the Fed will keep interest rates near to zero, this will push down the value of the American dollar and help boost America’s economic growth. Such a move would produce protests from the euro zone and Japan, but this change in currency value would be solely China’s responsibility.
If China stops buying foreign assets altogether, this would of course be equivalent to ending foreign-exchange intervention. This is exactly the policy change that we should be seeking.