Monday, January 26, 2009
In Tim Geithner's written responses to questions from the Senate Finance Committee that recently approved his nomination to be our next Treasury Secretary, he says that President Obama "believes that China is manipulating its currency."
I would agree with him that China has been "manipulating" its currency, but only in the sense that the rate of exchange between the yuan and the U.S. dollar has been far more stable than if it had been left to the vagaries of the market. I would hasten to add, however, that most of those who accuse China of "manipulating" its currency also believe that the Chinese currency should be far stronger against the dollar than it currently is (and, by inference, the U.S. dollar should be far weaker). I take great exception with anyone, especially our Treasury Secretary, who believes the U.S. dollar should be weaker against any currency. A strong currency is always in every nation's best interest, because it provides the bedrock for confidence, investment, and progress. Geithner is starting off on the wrong foot.
In any event, as this chart shows, the Chinese yuan has been strengthening against the dollar for the past 14 years. What more do weak-dollar advocates want? The Chinese are guilty of "manipulating" their currency only to extent that they have sought to slow the pace of its appreciation vis a vis the dollar. But is that "manipulation" in the sense of doing something wrong? No.
According to the teachings of international finance, a country can manage its currency in only one of three possible ways: by targeting an interest rate (typically the overnight lending rate); by targeting the quantity of money in circulation (e.g., Volcker's targeting of M2); or by targeting its exchange rate vis a vis another currency or basket of currencies. When you target one monetary variable, the others find their own level and the economy adjusts. The Chinese economy has had plenty of time to adjust to its currency target.
Since 1994, the Chinese have targeted the exchange rate of the yuan vis a vis the dollar. They have done this by buying up most of the capital inflows (call them dollars) that were seeking to enter the red-hot Chinese economy. If they hadn't bought the excess dollars seeking to purchase yuan and yuan assets, the yuan would have appreciated much faster. This is perfectly acceptable; by purchasing the excess of dollars (a trillion or so), the Chinese central bank created new currency, which was then absorbed by an economy growing in excess of 10% per year. And by amassing a huge pile of foreign reserves in the proces, the Chinese central bank has given the yuan rock-solid status, and that is a boon to the Chinese economy because it guarantees that investments in China won't be wiped out by a devaluation. A strong Chinese economy that can sell us cheap and quality goods is a win-win for everyone.
Geithner was confirmed with haste, and his sins were overlooked, all in the name of responding quickly to the current economic crisis. That sounds a lot like what the Obama administration is trying to do with the stimulus package. These are ill-considered moves, wrapped in the cloth of urgency, which are more likely to result in a permanent expansion of government than a quick resolution to our problems.
And this is one more reason why our stock and corporate bond markets are so depressed.
Posted by Scott Grannis at 7:49 PM