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Finding a way out

Geithner's predecessor Henry Paulson pointed to international imbalances as one of the crisis' causes. Meaning that Americans were borrowing and spending much, and Asia -- China in particular - was saving much and spending little.

Edward Gresser
AS the United States bails out banks and shoe-factories close their doors in China, should the two governments worry about exchange rates?
The question arose after Timothy Geithner, US treasury' secretary, suggested that China is "manipulating’' the value of its currency. China fired back, echoed by a chorus of financial-gallery alarm over potential trade conflicts. But a reading of Geithner's full comment should dispel fear of a looming trade war over exchange rates: What the US seeks is a coordinated approach to save both economies from sinking.
Geithners argument was that Chinese currency rates are a topic that both governments need to address. Noting the manipulation point, he continued:
"We look .forward to a productive economic dialogue with the Chinese government on a number of short- and long-tem issues. The Yuan is certainly an important piece of that discussion, but given the crisis the immediate focus needs to be on the broader issue of stabilising domestic demand in China and the US... Because China accounts for such a large fraction of the world economy, a further slowdown in China would lead to a substantial fall in world growth (and demand for US exports) and delay recovery from the crisis. Therefore, the immediate goal should be for us to convince China to adopt a more aggressive stimulus package as we do our part to try to pass a stimulus package here at home."
The world needs more balanced growth in the next decade. Change in Chinese currency policy is part of this. But the immediate problem is accelerating economic collapse. Meanwhile, the imbalances that can arise from currency misalignments are fading as America's imports and deficits shrink. So, though both countries need to address the causes of their illness, they can afford to wait until both patients feel better.
Why are currency rates relevant?
Currency rates are a way to moderate swings in global growth and trade flows. A high currency value makes exports expensive, imports cheap, and can slow growth when inflation threatens. A low currency value helps countries escape from economic slumps through cheaper exports.
Currencies of most big economies swing back and forth in this way, traded at rates of S3 trillion per day. China's yuan is the exception, set in a band by government policy.
This is not inherently unworkable. But if setting does not change with economic conditions, it can lead to big surpluses, deficits and risks. Here, we
have one source of the crisis.
Geithner's predecessor Henry Paulson pointed to international imbalances as one of the crisis’ causes. Meaning that Americans were borrowing and spending much, and Asia -China in particular — was saving much and spending little.
This is not a new phenomenon. Americans shop a lot and save little, relying on the worth of home ownership to build wealth. They save 5% or 6% of GDP in normal times; Asians save 20% to 40% of GDP. The result is an imbalance, with Americans buying more and Asians selling more than buying.
Americans have run deficits with Asia not only since the 1970s, but throughout the 19th century and the first half of the 20th century. But imbalances of this decade grew larger and faster than those of earlier periods. US government policy drove American savings rates to just above 1% of GDP, the lowest figures recorded since 1934.
Chinese savings and low consumption helped create a high pool of capital and a steadily growing trade surplus. By 2006, America maintained a currentaccount deficit equivalent to almost 6% of American GDP -- an all-time record, and double the deficit of2001.
China's surplus, meanwhile, rose from rough balance in 2003 to a 10% of Gt)P surplus in 2007, with a mirroring increase in American manufacturingtrade deficits. A fixed currency rate for the Chinese RMB, at 8.28 to the dollar from 1994 to 2005, meant currency did not respond to these changing conditions.
Geithner is therefore right to say that the yuan level is an important issue. Nor is he alone -- in the high-growth period of 2004 to 2007, economists at the International Monetary Fund and universities politely protested both Chinese currency policy and America's low savings and tax-cut mania.
Americans would have to save more and shop less. Chinese would need to export less, sell more at home and shift employment from export factories to new sources of prosperity and create domestic demand. Chinese currency did appreciate after 2005, and America's imbalance did begin to shrink, but only by a modest amount, and China's surplus continued to grow.
At some point, which nobody can quite predict, a rising imbalance becomes a risk. Both countries are seeing the consequences -- trembling banks in America, shuttering factories in coastal China, and rising unemployment in both countries.
Governments need to set their recovery on a more solid foundation than the one of 2003-2006. This will require a more flexible currency in China that can moderate any returning boom, as well as better regulation and more savings in America.
But as Geithner pointed out, timing is everything. Imbalances are not the world’s big problem. Markets reduce them by force, as demand collapses. With unemployment up, American families no
longer go shopping. Imports are therefore plunging, from $229 billion in July to S183 billion by November; imports from' China fell from about $33 billion to $28 billion.
This is the fastest US import drop since the Second World War. As imports fall, America's trade gap shrinks, from an annualised S720 billion in early 2008 to $530 billion by the winter. Across the Pacific, Chinese migrant workers from the coastal industrial zone head home as export orders dry up. China's surplus may accordingly drop.
This collapse in demand is now the big evil governments must meet. Rising imports and imbalances may return, but are not the problem today. A confrontation over these matters would do little to solve the day's big evils, but could make them worse.
Therefore, as Geithner pointed out, currency should not be the immediate concern. Instead the US and Chinese governments need to cooperate, coordinating stimulus policies to give maximum support to demand.
As they restore growth, they must find ways to make it balanced growth. As ordinary people worry about jobs and growth, governments should think about the foreign-exchange markets. But they should act at the right time. Geithner's comment about currency, taken in its full context, implies that the Obama team is thinking along these lines. If so, they suggest the intention to restore health first, then place the prosperity of the 2010s on a stronger foundation than this decade's expansion — not a bad goal at all.
Edward Gresser is director of the Trade & Global Markets Project with the Progressive Policy Institute.
© Yale Center for the Study of Globalization. All rights reserved. Reprinted by arrangement