Because China has pegged its undervalued currency, the yuan, to the US dollar, every weakening of the dollar in the wake of the financial crisis has also meant a weakening of the yuan vis-a-vis other world currencies. However, is China really to blame for the eruption of a global currency war?
The central banks of Taiwan, South Korea, Brazil, Japan, Switzerland and many other countries are now buying US dollars to protect their own currencies against revaluation and thus defend their exports. Europe also became nervous after the euro exchange rate rose to more than US$1.40, far beyond the purchasing power parity (PPP) rate of US$1.17.
The US is now taking drastic steps against China and is making provisions for a trade war. The US Congress has authorized US President Barack Obama to impose import duties on Chinese products if China remains unwilling to increase the value of its currency substantially against the US dollar.
However, the undervaluation of the yuan, which is currently 45 percent, has persisted for many years, so why is the US suddenly acting aggressively? Why didn’t it take action earlier?
The reason lies in capital movements. The US accepted the lower valuation of the yuan as long as China returned the dollars it earned from bilateral merchandise trade by financing the US 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 US policymakers.
China’s shift has been dramatic. In 2008 and last year, the Chinese purchased US government bonds at a rate of US$17 billion a month. However, China reversed course in November.
During the first seven months of this year, 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 US$7 billion in US government bonds. That nerves are now on edge in the US is perfectly understandable.
The City of London has jumped into the breach, increasing its purchases, which in 2008 and last year amounted to only about US$1 billion monthly, to an average of US$28 billion in the first seven months of this year. Since the UK 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. In 2007 and 2008, China exported on average about US$400 billion of capital annually. The US, which at the time needed annual capital imports of US$800 billion 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 the US 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 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 US 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 yuan’s low valuation that allowed US citizens to buy into the American dream of universal home ownership.
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 standard of living in the US.
It is understandable that China is 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 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 doing 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 dictates.
Hans-Werner Sinn is a professor of economics and public finance at the University of Munich, and president of the Ifo Institute.
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