Greenspan and the Yuan

Crooked Timber is lucky enough to have recruited the services of the late Sir Montagu Norman as an economics correspondent. He will be contributing occasional dispatches from beyond the grave. He opens his account with us with some pointed remarks on the Chinese Yuan …

Mr Greenspan and the Chinese Yuan

Strange days indeed. Mr Greenspan of the Federal Reserve is making extraordinary remarks about the Chinese (Renminbi) Yuan. He says that the yuan is undervalued, and that China “must” allow its value to float. If I may be permitted in death to drop the Sphinx-like discretion which marked my career, Mr Greenspan is talking bloody nonsense. As he well knows, the Chinese are cannot be forced to do anything.

The issue is a familiar one to those of us of the older school. It is the question of the external, internal and temporal value of money; the triple problem of the exchange rate, the rate of inflation and the rate of interest. Under the laissez-faire theory which is currently orthodox in the West, a central bank acting alone is able to control at most one of these. But China is not a laissez-faire country.

Because it has the will to make a prices and incomes policy stick, and because it has the power to control the domestic banking system, China has been able for several years to maintain a low domestic interest rate, a fixed rate against the US dollar and a stable (mildly deflationary) price level.

Of course, this means that China is able to take a free ride on the stimulative effect of a falling US dollar globally, and Mr Greenspan no doubt wishes that it would not. The period of the peg and cheap-money policy has coincided with one in which the USA has collectively decided to consume well beyond its means, ensuring that (as part and parcel of a general trade deficit), China has developed a large surplus on the current account with respect to the United States of America. As well as reducing the stimulative impact of Mr Greenspan’s own cheap-money policy, this has led to a situation in which China has become a large net acquirer of US dollar assets. Leading, not unnaturally, to a situation in which Mr Greenspan is perhaps concerned that China will choose one day to realise these assets, with a consequent serious financial dislocation.

A serious problem, then, but a problem for China? I think of my own experience in the 1930s, and I think not. In a gold-standard, the burden of adjustment falls obviously on the deficit country. In a greenback-standard, the burden is less obvious and perhaps even less onerous, but it is still the creditor country which holds the cards. If the USA is to meet its debts to China, then it must either one day run a surplus, or default, or inflate its debt away. China has no such obligation to the USA. I see no reason in theory or experience to make me believe that China’s acquisition of US dollar assets will “put its monetary system at risk”.

It is true that the current low interest rate may lead to “an investment boom” in the Chinese economy, or indeed, to what we apparently refer to as “overheating”. But the Chinese government controls the price level and the interest rate. Unlike a laissez-faire monetary authority, they can act to solve domestic problems without needing to adjust their exchange rate. There are surprisingly few constraints on the actions of a government with a working incomes policy and a surplus on the balance of trade.

It appears to me that Mr Greenspan is bluffing a weak hand and knows it. America’s trade deficit has nothing to do with the Chinese yuan. It is a result of a cheap-money policy explicitly aimed at ensuring that the population as a whole consumes more than it earns. This policy keeps the wolf from the door in the near term, but makes it a mathematical inevitability that the USA will run a trade deficit with respect to somebody; if not the Chinese, then somebody else.

The fact that it is the Chinese rather than anyone else (or indeed, as well as everybody else) may be considered worrying. The Republic of China is the United States’ only credible rival as an imperial power, and they appear to be aware that genuine hegemons tend to import capital, not export it. But this is politics, and I am only a central banker, albeit one with a long memory.

As a member of Professor von Mises’ Institute notes, his problem is not dissimilar to one that I faced myself, and perhaps did not cover myself in glory in my handling of it. What a shame that Mr Greenspan has no Chinese equivalent of Ben Strong to help him out. The dogs bark …

Update: “Overvalued” corrected to “undervalued”