By Simon Johnson
On his China visit, Secretary Geithner is immediately on the defensive. The language he is using on the Chinese policy of exchange rate undervaluation-through-intervention is the mildest available. And the commitment he is making, in terms of bringing down the US deficit – which we all favor – is an extraordinary thing to put numbers on in a foreign capital. Such commitments are of course unenforceable, but still the wording indicates – and is understood by China – great US weakness.
Not surprisingly, China seems likely to push for more. Their main idea is that some part of their US dollar holdings be transferred to a claim on the International Monetary Fund, which would shift it from being in dollars to being in Special Drawing Rights – and therefore a claim against (a) the IMF’s whole membership, and (b) presumably, the IMF’s gold reserves.
This is a bad idea.
No one asked China to build up a huge level of reserves. If one country wants to run a current account surplus that is big relative to the international economy, then someone else has to run a deficit – it’s a zero sum game because “reserves” are a claim on another country (preferably a strong one, with a convertible currency). No one has ever offered a guarantee on the real value of reserves, i.e., what China now wants.
We can agree that the US should have a higher savings rate, but if we did have more savings – or even if we ran a current account surplus of our own – China’s desire for foreign exchange reserves would still mean undervaluation for them (as along as they can sustain the intervention) and a current account deficit for some set of countries in the rest of the world.
There is nothing wrong with wanting to have foreign exchange reserves, and sometimes these are accumulated just through the natural cycle of activity (e.g., commodity producers are well advised to build up reserves in a boom, because the prices of their exports also crash with some regularity). But the way China has operated within the global system has not been responsible and it has not – an important point – been in conformance with the rules (as reflected most recently in the IMF’s Surveillance Decision, which is heavy on the legalese but quite clear on this point: no sustained undervaluation through intervention in the currency market is allowed).
China needs to acknowledge that it too has responsibility for the stability of the international system. Current account surpluses feel good for surplus countries – this has been a consistent feature of the modern global payments system – but policies that sustain big surpluses are destabilizing for that system, because they imply that someone else will run a deficit and, more than likely, eventually have to bring that deficit down through costly adjustment.
What we really need is a complete reform of the IMF – or the introduction of a new international payments body - so that countries don’t feel the need to run massive surpluses to protect themselves against external shocks.
In the meantime, we need China to allow its currency to appreciate. If they double their holdings of US dollar assets over the next couple of years (let’s say, going towards $4trn), effectively financing our budget and current account deficit, will we all end up safer or more vulnerable?
Is Mr. Geithner trying to persuade China to reflate a new version of our financial bubble?