EDITORIAL: "The Yuan Scapegoat: The U.S. establishment flirts with a currency and trade war with China," Wall Street Journal, 18 March 2010.
Clear start: "The U.S. is more wrong than China here . . ."
The danger is described as "begger-thy-neighbor currency protectionism."
The imagined relief: "If the Chinese would only let the yuan 'float,' it would soar in value, China's export advantage would fall, and the much-despised 'imbalances' in global trade would end."
The "basic misunderstanding of monetary policy" at the center:
There is no free market in currencies, as there is in wheat or bananas. Currencies trade in global markets, but their supply is controlled by a cartel of central banks, which have a monopoly on money creation . . . A fixed exchange rate is also not some nefarious economic practice rare in human affairs.
Many countries peg to the dollar (usually small economies) and with the euro's creation most of Europe is de facto pegged. The obvious goal: a stable currency that "eliminates a major source of uncertainty for investment decisions and trade and capital flows."
When China pegs, it outsources monetary ploicy to the US Fed. This has not hurt the global economy. Indeed, it was a key component of the latter half of globalization's lengthy boom (1982-2008).
But the US now pressures China to change this approach, even though (as I have often pointed out in the past but not recently) "much of this deficit is intra-company trade" (American companies go to China, use the labor, and then "export" back to their US units, meaning US companies control much of China's exports).
China did let the yuan appreciate slowly in the 2005-2008 timeframe, but that 18% had little-to-no impact on the trade imbalance. It repegged when the crisis hit.
China, the WSJ argues, is correct to resist the pressure, otherwise it will repeat Japan's mistakes in acquiescing similarly in the late 1980s and early 1990s. The result?
As Stanford economist Ron McKinnon has show, one result was domestic deflation in Japan and its lost decades of growth. Meanwhile, Japan continued to run a trade surplus . ..
Simply put, China's economic growth is too important to the global economy right now to be messed with.
What really needs to change is not the peg so much as the inconvertibility of the yuan.
These controls have blunted the yuan's development as a tradable currency, which means private markets can't recycle the flow of dollars into China from its large trade surplus. Instead, the job is left to China's central bank, which buys dollars deposited in Chinese banks with yuan. This is why the central bank has accumulated some $2.5 trillion in dollar reserves.
Instead of that money finding better use, too much simply gets shoveled back into US T-bills and Fannie Mae securities, not helping our real problem--our lack of fiscal discipline.
If the yuan was convertible, then China would recycle its surplus like Germany does.
Given all the back-and-forth I read on the peg issue, this strikes me as sounder logic. I have often, in the past, make the mistake of conflating the two issues (to make convertible is to allow to float). These are better distinctions worth remembering.
This is why we read the WSJ--to become smarter on such issues.
Sunday, March 28, 2010 at 1:40PM 
