« The State of the Trade Deficit | Main | Misspeaking »

February 11, 2005

Keeping the Yuan Down...

John Berry delivers the rest of the conference report on last Friday's Federal Reserve Bank of San Francisco dollar-yuan conference. Berry believes that the yuan will stay low for quite a while: that China's State Council doesn't realize what the long-run costs of its policy are, and even if ti did realize them might think the money well-spent:

Bloomberg Columnists: Federal Reserve officials aren't optimistic that China will drop its currency peg against the dollar anytime soon because that decision is in the hands of a State Council focused primarily on political stability rather than financial issues... believes that China's political stability hinges on continued strong economic growth that will provide the tens of millions of new jobs needed by workers moving out of agriculture and into the industrial economy. And that growth in turn is seen as dependent on keeping the yuan pegged tightly to the dollar.

Fed Chairman Alan Greenspan has said that keeping the yuan pegged to the dollar means that the People's Bank of China, the country's central bank, can't control the nation's money supply. As a result, mounting inflationary pressures eventually will force a revaluation of the yuan, he has said. At the same time, keeping the peg has forced the central bank to accumulate well over half a trillion dollars worth of foreign exchange reserves, mostly U.S. dollars....

In a speech in Washington on Feb. 9, Timothy F. Geithner, president of the New York Federal Reserve Bank, cited two major risks to world economic growth. One is the increasing government debt-to-GDP ratios in most of the major economies. ``At the same time,'' Geithner said, ``external imbalances have reached unprecedented levels, most dramatically in the case of the U.S. current account deficit, which is on a path to exceed 6 percent of GDP. These imbalances -- fiscal and external -- cannot be sustained indefinitely. Each magnifies the risk in the other.... The present system, where the major currencies adjust against each other, but many large emerging market economies tie their currencies to the dollar or shadow it closely, creates an awkward asymmetry. This system carries with it the seeds of future stress for the global economy,'' Geithner warned.

At a symposium at the San Francisco Federal Reserve Bank last week, more than 30 economists, mostly from universities and international institutions, tackled the issue of China's currency peg. Most of them argued that the Chinese would be forced to adopt a more flexible exchange rate regime, and some said that would come no later than next year.... [T]he symposium... discuss[ed] a series of papers by economists who maintain that the Chinese have such an overriding interest in strong growth that the peg will last at least for another five years.... Peter Garber... told the group, ``I don't think anybody disagrees that this eventually will come to an end.'' That probably will only happen ``when the labor supply is absorbed,'' he said.... The heart of the Dooley and Garber analysis, in which David Folkerts-Landau, another Deutsche Bank economist, has participated, is that the current situation in China and other East Asian nations resembles that of Western Europe in the 1950s after much of it was devastated by World War II.... ``If the price to be paid for this (industrialization) strategy includes financing a large U.S. current account deficit, governments in the periphery will see it in their interest to provide financing even in circumstances where private international investors would not....

No one [else] at the symposium expressed support for the notion that the Chinese would be able to maintain their peg nearly as long as Dooley and Garber said they could. Nouriel Roubini of New York University was the most vociferous among those attacking Dooley and Garber's view. ``It's not sustainable and will unravel,'' Roubini said. ``Once central banks signal less willingness to finance,'' that will trigger a massive private investor rush out of the dollar. Edwin M. (Ted) Truman, a senior fellow at the Institute for International Economics and former head of the Fed Board's Division of International Finance, referred to the papers as ``musings'' and said their ``view is incorrect and their framework does not provide a useful guide for analysis or policy. A continuation of a U.S. current account deficit of 6 percent of GDP is neither economically, financially nor politically sustainable,'' Truman said. ``The large economies with more or less firm pegs to the dollar inevitably will have to be part of the adjustment process.''...

Posted by DeLong at February 11, 2005 09:58 AM