June 2, 2004
When the G-8 ministers meet at Sea Island next month,
they invariably will discuss the adjustment of currencies to economic
imbalances. In particular, they
will ask Japan why they intervene so much to alter the value of the yen.
They also will grumble at the virtual stability of the Chinese
currency against the U.S. dollar.
In anticipation of such complaints, the Chinese Finance
Ministry addressed this subject with a group of international journalists a
week ago.. The increased
inflation currently developing in China as well as reductions in tariff
restrictions required to be in compliance with World Trade Organization
guidelines were mentioned as already creating a de facto 8 to 9 percent
revaluation in the Chinese currency.
Not surprisingly, most of the journalists were confused
by coupling inflation and WTO required changes with currency valuations.
In fact, the Chinese position was correct.
More open trade and domestic inflation both lead to increased demand
for imports and reduced competitiveness of domestic producers.
However, they are wrong to assume that these changes preclude a
currency revaluation. To the
contrary, they almost demand one.
Economic systems have natural tendencies to regain
balance. If quantities demanded
are too high, prices rise until either some consumers find alternatives or
so much purchasing power is exhausted in buying the good that other economic
activity suffers. This leads to
rising unemployment and lost paychecks until the excess demand vanishes.
There are exceptions to this tendency.
They usually occur when the adjustments to the imbalance undermine
the foundations of an economic system.
For example, banks may collapse or bankruptcies may rise so high that
even worthwhile projects are being ignored by lenders.
However, those depression type outcomes do not normally
occur. (Indeed, many economists
believe policy failures as well as system failures are needed to create a
Nevertheless, if tariffs, regulations, or central bank
intervention prevent normal price adjustments from removing economic
imbalances, then alternative adjustments will develop.
If an increasingly competitive economy does not allow the market to
change its currency, then assets will flow to that country.
This will push up prices of resources and eventually spawn domestic
inflation. Ultimately, an asset bubble and rising inflation will create
a rising risk to economic stability.
This increasing risk to stability is where the Chinese
economy is at the present time. In
other words, rising inflation
is a poor alternative to rising currency values for the Chinese economy.
The fact that inflation is continuing to rise in China indicates that
the de facto revaluation remains far from sufficient to restore balance
between the Chinese and other economies.
Here is where someone ought to argue that if the
Chinese want to provide cheap goods to our consumers, why should we worry?
Are they not subsidizing our households?
Of course they are.
But they also are undermining our manufacturers.
If the current relative currency values are the appropriate ones,
then we should release resources in our now inefficient industries so they
can be redirected to greater value for our economy.
(I acknowledge that some towns will lose their economic base and
substantial investment may lose value more rapidly than if no international
competition existed. Economic
transitions are not pleasant.)
However, if those currency differences are not
appropriate, some of our industry may disappear despite being viable if
currency values had not been distorted by government controls.
Moreover, the major problem is that only if market
forces are permitted to determine currency values will we get some inkling
of what values are appropriate.
We now can say with some assurance that the current
value of the yuan is not appropriate because Chinese inflation is growing
faster than world inflation. Indeed,
Chinese inflation is beginning to push up world prices because of this
(If prices should have changed but didnít, that is a
distortion. Fixed prices that
are wrong become distorted when changing economic conditions make those
Frankly, the Chinese Finance Ministry is absolutely
wrong in waiting for Chinese inflation to effectively revalue their
currency. By the time that
happens, inflation will be blossoming world-wide, otherwise viable
industries will have disappeared, and the imbalances in China itself will
have threatened a serious economic correction.
I hope they really understand what the costs of currency price fixing can be to their country and to the world.