An article in the FT today puts the US-Chinese economic/trade relation in an interesting perspective, i.e. from the Chinese point of view.

China’s leaders are preparing their people for an end to the policy of pegging the renminbi to the US dollar, the bedrock of economic policy for a decade. [This] would have big implications for China’s economic management and, some in Beijing think, for its development strategy predicated on foreign direct investment inflows and export-led growth.

China’s exchange rate is also central to the growing debate over whether the current imbalances in the global economy – whereby the US has a large current account deficit while other countries accumulate dollar assets – can be sustained. Pressure on China to alter its exchange rate is particularly strong from Washington. The US Congress may force President Bush’s administration to take more aggressive steps to curb the trade deficit with China, which this week ballooned to a new record.

This is another look at global imbalances and their domestic implications both in China and in the US, and some suggestions for the Us domestic politics.

China’s dollar dilemma (Financial Times, 14 April)
Some economists wonder if US lawmakers know what they are wishing for. China and other Asian countries have – because of massive dollar purchases to prevent their currencies appreciating – emerged as the financiers of the US’s current account and fiscal deficits, providing cheap capital that has kept the dollar’s decline orderly and helped bring economic growth and low interest rates.

Sooner or later these countries may decide this is no longer in their interests. They face capital losses on their reserves as the dollar declines, while running the economy according to an exchange rate target means abandoning control of domestic policy. Market rumours of possible slower accumulation of dollar reserves, or diversification into other currencies, by smaller Asian countries have caused volatility in financial markets in recent months. A shift in China’s exchange rate policy could have a far greater effect.

China’s current policies are to the advantage of the US (and obviously in the interest of China’s export-led growth), but they also have some downsides for the Chinese:

There would be capital losses if the renminbi appreciated. Economists estimate three-quarters of China’s foreign reserves of more than $600bn are held in US dollar assets.

Yu Yongding, a member of the monetary committee of the People’s Bank of China, the central bank, acknowledges that it is difficult to calculate an ideal level for foreign exchange reserves. But he says of the current level: "There is no doubt whatsoever that it is too high, entirely unnecessary and a waste of financial resources."

A shift in exchange rate policy would also allow the government to use monetary policy for domestic goals, rather than subordinating interest rate decisions to the management of the renminbi. This might be very useful at a time when, according to many economists, the Chinese economy is in danger of overheating.
(…)
Exchange rates are subservient to China’s overarching aim of maintaining annual economic growth of about 7 per cent to 8 per cent, creating the 15m to 20m jobs a year that the government believes are needed to maintain social stability and meet expectations of higher living standards.

Indeed, the debate over the renminbi goes to the heart of the way China has built its economy since Deng Xiaoping lifted it out of its post-Maoist torpor in the late 1970s. Foreign investment has produced jobs but has in some eyes turned China into little more than a processing centre for goods that are sent on to the US and Europe.

Guo Shuqing, formerly head of the State Administration of Foreign Exchange, said in a recent interview with a state-run newspaper that "indiscriminate support of exports" and "fake foreign investment" had begun to cause problems for the economy. "We should gradually reduce the preferential treatment to exports and seriously review our foreign investment policy," he argued.

The current global arrangements are really like a drug:

• they have provide a boost to the parties – the US gets to consume cheap goods on credit, the Chinese get export-led growth and standards of living;
• many constituencies are now  "hooked" and cannot function without it: Chinese exporters (including a number of Western investors), the US authorities, happy to be able to have spending power at no apparent cost (just print more money), and Chinese authorities who have found an easy way to avoid social unrest.

But there are growing nasty side effects, both on a global scale and domestically:

• the global unbalances have been discussed in other threads, so I won’t go back into them, but there is a growing worry that they are unsustainable and that there is a real risk of a "hard landing";
• in the US, the trade deficit with China is causing politicians to push for corrective measures, the most frequent ones being protectionism; there is also the fear that outsourcing the industrial base of the country to China is hollowing out the country and leaving it with bad jobs at Wal-Mart in a self-feeding vicious circle. But China is only the symptom of the above unbalances, and blaming the symptoms will not cure the underlying problems;
• in China, more interestingly; there are growing voices to say that the current model of growth is no so advantageous for China, as it unduly favors exporters (which are not really Chinese) and does not help to develop a domestic market so much; also, the scale of the monetary unbalances is having a toll internally as the country struggles with towering reserves on which it bears a risk that they will lose value and which are becoming increasingly hard to "sterilize" as the capacity of the domestic bond market is saturated. The threat of inflation is becoming very real again and this is a risk that Chinese authorities really want to avoid.

And like with Iran, US pressure is counter-productive:

If China’s policymakers are in accord on one issue, it is that the exchange rate system should not be used as a tool to assuage US ire over the bilateral trade imbalance. "No country can base its currency policy on bilateral trade imbalances," says one senior Chinese official. "If that was the case, then Washington should be pressuring Saudi Arabia to revalue its currency."

Bert Keidel, a former economist at the World Bank in China and former Treasury official who is now with the Carnegie Endowment for Peace, a Washington-based think-tank, says pressure from the US is not helpful. However much sense it might make for China to change its currency regime sooner rather than later, US pressure is likely to produce the opposite result: "There is one constituency which says, if this is what the Americans really want, then screw them."

As with all drugs, addiction makes it hard to stop, and all parties are hoping that a "soft landing" can be found. And who knows, it might be possible if you did not have reckless spenders in the White House (Stirling Newberry’s latest diary – go read it) keen on making the bubble ever bigger to blow it in favor of the narrowest of constituencies, the ultra-rich and the big corporate bosses.

Rather than blaming the Chinese for what are mostly homegrown problems, the Democrats should focus on the following:

• the main culprit is Bush’s reckless deficits which forces the country to rely on foreign capital and creates a nasty dependency (Irresponsible – and dangerous for national security);
• the debt thus generated additionally is used to give money to the ultra rich (as previous tax cuts and the latest repeal of the estate tax show) and to the greedy corporates that would rather invest in China than in the US (policy hijacked by narrow interest groups);
• meanwhile some of the underlying  reasons why firms are not investing in the USA (out of control health care costs, stagnant purchasing power) are not being addressed (they don’t care about the average American’s economic situation)