China As Imperialism’s Target

C P Chandrasekhar

IN mid-July, Alan Greenspan, chairman of the US Federal Reserve, while deposing before a congressional committee, warned the Chinese authorities that they could not continue to peg the renminbi to the US dollar, without adversely affecting the functioning of their monetary system. This touching concern for and gratuitous advice to the Chinese had, however, some background. Greenspan was merely echoing the sentiment expressed by a wide circle of conservative economists that the Chinese must float their currency, allow it to appreciate and, hopefully, help remove what is being seen as the principal bottleneck to the smooth adjustment of the unsustainable US balance of payments deficit.

IMPERIALIST OFFENSIVE

China was, of course, only the front for a wide range of countries in Asia, who were all seen as using a managed and “undervalued” currencies to boost their exports.  Around the same time that Greenspan was making his case before the congressional committee, The Economist published an article on the global economic strains being created by Asian governments clinging to the dollar either by pegging their currencies or intervening in markets to shore them up. That article reported the following: “UBS reckons that all Asian currencies, except Indonesia’s are undervalued against the dollar … The most undervalued are the yuan, yen, the Indian rupee and the Taiwan and Singapore dollars; the least undervalued are the ringgit, the Hong Kong dollar and the South Korean won.”

Besides Greenspan and The Economist, big names such as John Snow, US treasury secretary, and Kenneth Rogoff, IMF chief economist have joined the fray to make the case. The evidence to support this is of course limited.  It lies in the fact that while over the year ending September 3 the euro has appreciated against the dollar by about 9 per cent, many Asian currencies have either been pegged to the dollar, appreciated by a much smaller percentage relative to the dollar or even depreciated vis-à-vis the dollar.

This new imperialist offensive is surprising given the fact that till recently, developing countries were being accused of pursuing inward looking policies, of being too interventionist in their trade, exchange rate and financial sector policies, and, therefore, of being characterized by “overvalued” exchange rates that concealed their balance of payments weaknesses. Thus devaluation (and not upward revaluation) was a common prescription in most World Bank-IMF conditionality packages. Together with, it was argued, in medium term countries must substantially liberalize trade, shift to a more liberalized exchange rate regime, resort to less intervention all-round, and ensure a greater degree of financial sector openness. Partly under pressure from developed country governments and the international institutions representing their interests, many of these countries have since put in place such a regime.

What needs to be noted is that this change in regime was what has led up to the current situation of burgeoning reserves in many countries. The regime change required governments to borrow less to finance deficit spending, which often led to lower growth, lower inflation and lower import demand. Combined with or independent of higher export growth, these effects showed up in the form of reduced deficits or surpluses on their external trade and current accounts. Since in many cases the ‘chronic’ deflation that the regime change implied was accompanied by large capital inflows after liberalization, there was a surplus of foreign exchange in the system, which the central bank had to buy up in order to prevent an appreciation in the value the nation’s currency. Currency appreciation, by making exports more expensive and imports cheaper, could have devastating effects on exports in the short run and generate new balance of payments difficulties in the medium term. In fact, among the reasons underlying the East Asian crises of the late 1990s was a process of currency appreciation driven by export success on the one hand and liberalised capital inflows on the other.

STABLE EXCHANGE RATE REGIME 

Faced with this prospect countries like China, for example, chose to make a stable exchange rate a prime objective of policy and has frozen its exchange rate vis-à-vis the dollar at Renminbi 8.28 to the dollar since 1995. To its credit, it stuck by this policy even during the Asian currency crisis, when the value of currencies of its competitors like Thailand and Korea depreciated sharply. This helped the effort to stabilize the currency collapse in those countries, even if in the immediate short run it affected China’s trade adversely.  India too had adopted a relatively stable exchange rate regime right through this period, allowing the rupee to move within a relatively narrow band relative to a basket of currencies, and not just the dollar.

However, the overall policy of liberalization entailed providing relatively free access to foreign exchange for permitted trade and current account transactions and the creation of a market for foreign exchange in which the supply and demand for foreign currencies did influence the value of the local currency relative to the currencies of major trading partners. This made the task of managing the exchange rate difficult. The larger the flow of foreign exchange because of improved current account receipts (including remittances) and larger inflows of capital consequent to limited capital account liberalization, the greater had to be the demand for foreign exchange if the local currency was to remain stable. But given the context of extremely large flows (China) and/or relatively low demand due to chronic deflation (India), there was a tendency for supply to exceed demand, even if this did not always reflect a strong trading position. As a result, to stabilize the value of the currency the central banks in these countries were forced to step in, purchase foreign currencies to stabilize the value of the local currency, and build up additional foreign exchange reserves as a consequence.

IMPLICATIONS OF RESERVES

The net result is that most Asian countries – those that fell victim to the late 1990s financial crises, like Korea, and those that did not, like China and India --- have accumulated large foreign exchange reserves.  According to one estimate, Asia as a whole is sitting on a reserve pile of more than $1600 billion. This was the inevitable consequence of wanting to prevent autonomous capital flows that came in after liberalisation of foreign direct and portfolio investment rules from increasing exchange rate volatility and threatening currency disruption due to a loss of investor confidence. These reserves are indeed a drain on these systems, since they involve substantial costs in the form of interest, dividend and repatriated capital gains but had to be invested in secure and relatively liquid assets which offered low returns. But that cost was the inevitable consequence of opting for the deflation and the capital inflow that resulted from the stabilization and adjustment strategy so assiduously promoted by the US, the G-7, the IMF and the World Bank in developing countries the world over.

For long, there was no objection to such reserve accumulation, because these reserves were being invested in dollar denominated assets including government securities in the US and played an important role in financing the burgeoning current account deficit in the US. With America experiencing growth without the needed competitiveness, that growth was accompanied by a widening of the trade and current account deficits on its balance of payments. Capital inflows into the US helped finance those deficits, without much difficulty.  For example, UBS estimates that in the second quarter of 2003, the central banks in Japan and China bought $39 billion and $27 billion of dollars respectively. If these are invested in American assets they would finance close to 45 per cent of the estimated $147 billion US current account deficit in that quarter.

The indirect benefits of this arrangement are even greater. For more than a decade now, the US has benefited from a long period of buoyancy, so much so that it has accounted for 60 per cent of cumulative world GDP growth since 1995. That buoyancy came not because the US was the world’s most competitive nation in economic terms. Rather, till the turn of the last decade growth was accounted for by a private consumption and investment spending boom, spurred by the bubble in US stock and bond markets that substantially increased the value of the savings accumulated by US households.  The money market boom was encouraged by the flight of capital from across the world to the safe haven that dollar denominated assets were seen as providing.

Investment of reserves accumulated by the Asian countries was one important component of that capital inflow. With the value of their savings invested in stocks and securities inflated by the boom, consumers found confidence to spend. The only threat to US buoyancy throughout this period was the possible unsustainability of both the speculative stock market boom and the widening current account deficit in its balance of payments. Even the collapse of the stock market boom did not put an end to US growth (excepting in 2000), because the US government decided to finance its misadventure in Iraq with a large fiscal deficit.  Further, the boom was not aborted, because the rest of the world appeared only too willing to finance those deficits, even if at falling interest rates in some periods.

DOUBTS ABOUT US GROWTH

Now however, doubts are being once again cast on the sustainability of US growth. America’s twin deficits many economists fear would lead to a collapse of the dollar and global recession. In their desperation to find a solution, they have turned their attention to Asia, with the demand that governments, especially the Chinese government, should revalue exchange rates, so that adjustment in the US would be smooth and growth would be triggered in Europe and Japan.

Within the imperial order always fearful of a “hard landing”, this has created two imperatives. First, in the medium term, the world needs other supportive engines, which must be from within the developed economies. Second, till that time, and even thereafter, US growth must be sustained. The new discovery that Asian currencies, particularly the Chinese renminbi, is under- and not overvalued, stems from the second of these two concerns. With the US current account deficit expected to exceed 5 per cent this year, there are few who are convinced that it would find investors who would be confident enough to continue financing that deficit.  This is becoming clear from the fact that the share of the deficit financed by central bank investments is rising, as private investors grow more cautious. Thus, if the dollar is not to collapse, the US current account deficit must be curtailed and reversed.

However, this cannot be ensured by curtailing US growth and therefore the growth of US imports. It is necessary to boost exports, so that growth can coexist with a reducing trade and current account surplus. This is where China comes in. Even though China cannot boast of a very large trade surplus with the world as a whole, it notched up a record $103 billion trade surplus with the US last year. This is seen as a direct consequence of China’s undervalued exchange rate, which has been pegged to the dollar since 1995 despite rising capital flows and reserves. Thus, the story goes, if China revalues its currency vis-à-vis the dollar by anywhere between 15 and 40 per cent, depending on the advocate, China would absorb more imports from and be able to export less to the US, correcting the trade imbalance between the two countries.

But that is not all. If China revalues its currency, it is argued, Europe would improve its competitiveness lost as a result of the appreciation of the euro vis-à-vis the dollar and therefore the renminbi, allowing it to register higher export growth. Further, China’s revaluation would reduce the need to pressurize Japan to revalue the yen, despite its own surpluses with the US and the high level of its reserves. This deals with the danger that yen revaluation might abort the feeble recovery that Japan is experiencing after a decade of stagnation. These benefits could possibly yield the supportive engines needed to keep the world economy in flight.

ADVERSE EFFECTS ON CHINESE ECONOMY

What is missed out is the impact that the revaluation of the yuan would have on the Chinese economy. It is bound to adversely affect Chinese exports, increase imports into China’s more liberalised economy (post-WTO accession) and lead to deindustrialization. This at a time when the restructuring of state-owned enterprises is already increasing unemployment in China. The point is that this is unlikely to help the world economy. A revaluation of the renminbi may reduce China’s trade surplus with the US, but it is unlikely to trigger either export or output growth in the US. Rather, the space vacated by the Chinese in US markets would be occupied by some other trading country such as Vietnam, Korea or the Philippines. Further, those Asian countries that expect to gain from the renminbi’s revaluation would soon find that their current account surpluses and reserves are seen as grounds for identifying their currencies as undervalued and provide the basis for a revaluation demand.

India, with less than $90 billion of foreign exchange reserves is already being targeted. Whatever gains would occur from China’s revaluation would be short lived.

Further, if China and other countries, like India with rising reserves are deprived of those reserves on these grounds, the capital required to finance the current account and budget deficits accompanying US growth would soon dry up. This would drive up interest rates in the US, cut consumption and investment spending, make the current account deficit unsustainable, and ensure the collapse of US growth and the dollar that the revaluation is expected to stall.

In sum, the whole episode indicates that the desperation to protect the current imperial order is yielding a number of scatter-brained proposals. Economics has been reduced to deformed ideology, devoid of consistency and rationality. Fortunately, the Chinese have thus far stood their ground and refused to yield. Hopefully, other developing countries would also see where their best interests lie.