Wall Street & Markets

Why China should stop piling up dollars (and why it won’t)

By Justin Fox | September 23, 2009 | +

In today’s FT, Martin Wolf writes about China’s $2.1 trillion in foreign currency reserves:

It is little wonder such a huge exposure makes the Chinese government nervous. But nobody asked the Chinese to do this. On the contrary, US policymakers have consistently (and wisely) advised them to do the opposite. Having made what I believe was a huge mistake, the Chinese government cannot expect anybody to save them from its consequences.

A substantial appreciation of the Chinese currency is inevitable and desirable in the years ahead. The longer the Chinese authorities fight it, the bigger their losses (and the pain of adjustment) are going to be. What they have to do is cut those losses, by ceasing to accumulate yet more reserves.

This is a point worth reiterating. Every time a Chinese official expresses worries about the safety of that $2.1 trillion (the bulk of which is held in dollars), the U.S. financial media broadcasts the news as if it is a horrible and frightening prospect. But in fact acting on those worries (by allowing the yuan to appreciate against the dollar) is exactly what we want China to do. What’s keeping it from happening is extreme suspicion in China of such a course. It is an article of faith within the Chinese business community that Japan’s lost decade in the 1990s was the direct result of acceding to pressure from Washington to allow the yen to appreciate against the dollar. So it seems like any external attempt to pressure China into stopping with the dollar hoarding—which is what a lot of the G-20 crowd seems interested in doing this week—is going to run into an awful lot of resistance.

Related Topics: dollar, yen, yuan, Economy & Policy, Wall Street & Markets

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  • bryanfromhouston

    Nice observation Justin, but “not so fast!”
    .
    China really doesn’t care about the revaluation of the Yuan. They are advancing and supporting that alternative pragmatic argument because the real reason would spook the world markets and investors.
    .
    China has a population of at least 1 billion (probably much more) and yet they maintain a growth rate of 8% y-o-y since 1978. How is that possible?
    .
    SImple. The 8% growth rate is a lie. (Thanks Joe Wilson.)
    .
    The primary job of the Chinese politicians is to stay in power and find jobs for so many people while transitioning from a communist economic policy structure to a capitalist economic structure. The justification that Japan had a lost decade is a red herring.
    .
    The Chinese know that the real reason is that propping up the Yuan gives their manufacturers an inherent competitive advantage without being forced to yield Smoot-Hawley like tariffs which would send the U.S. and thus, the enitire world including Chine into a second global depresssion. That is the real motivation here and the 800 pound gorilla in the room that no one wants to talk about.

  • http://economix.blogs.nytimes.com/2009/09/23/what-were-reading-16/ What We’re Reading … – Economix Blog – NYTimes.com

    [...] 2.) Why China should stop piling up dollars (and why it won’t). [...]

  • pneogy

    @bryan: Do you have evidence that China’s 8% growth rate is a lie, other than it seems improbable? And do you really believe that the Chinese are propping up the yuan? Or that propping up the yuan would give Chinese manufacturers an advantage? If you mean that the Chinese are artificially holding down the exchange rate of yuans, I agree with you. I think China needs to do so, as I believe you imply, to provide employment to its growing workforce. The process will probably continue till China can transition from a predominantly export oriented economy to one that is more oriented toward domestic consumption.

  • jomiku

    Don’t you miss Brad Setser’s blog?

  • bryanfromhouston

    Pneogy,
    .
    All good questions. Let’s take each in turn.
    .
    China’s 8% growth rate
    -
    We know this is false because of simple arithmetic. Let’s examine the unemployment rate for a country with 8% y-o-y GDP growth and what do you find?
    -
    http://www.indexmundi.com/china/unemployment_rate.html
    -
    It is remarkably step-like for a country that has a 1 child per family policy. No, I am pretty sure that the Chinese government is making up these numbers out of whole cloth.
    -
    Propping up the yen by buying loads of US treasury issues and giving their manufacturers an implied competitive advantage….this is too easy.
    -
    Yes, I think this is just pretty much common sense.
    -
    The Chinese (it is widely known) hold about $2 Trillion of our debt. Further, (widely known) the fact is that the dollar is pegged to a Chinese yuan to completely hold both currency investors and speculators at bay.
    -
    It is additionally (widely known- meaning google with generate at least 15-20 hits and probably more) interesting that every economist in the world acknowledges that the yuan is probably undervalued and the effect it has on trade imbalances with the U.S. and Europe.

  • http://baselinescenario.com/2009/09/26/escape-from-punchbowlism/ Escape from Punchbowlism « The Baseline Scenario

    [...] In order for the Fed to actually be able to fully use monetary policy to keep the economy humming at full throttle, we need financial regulation (to avoid new liquidity being channeled into bubbles instead of real investment), better capital asset ratios (to help moderate moral hazard and asymmetric risk), and limited expectations of future dollar devaluation (which currently result from our huge debts, and China’s continued mercantilist policies that keep the dollar propped up). This latter point is not entirely intuitive, and I might argue that the best way to avoid future expectations of devaluation is get the Renminbi/Yuan revaluation (which everyone expects, but over which there is massive uncertainty) over and done with. China, however, is not too keen on this idea. [...]

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