Brad Setser

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Guess why Treasury did not issue the foreign exchange report?

by Brad Setser
October 18, 2004

The Treasury did not issue the foreign exchange report on Friday. Presumably, this is because it would have made the same set of arguments that last year’s report made, namely that China is not manipulating its currency. Not exactly something the Treasury wants to state publicly before an election.

The report puts any Treasury in a bind. The consequences of declaring a country to be manipulating its currency are so dire – basically trade war – that is always a strong desire to avoid finding manipulation. Better one or two days of public embarrassment than initiating a fight with China that might get out of control. The right policy here is pretty clear: use the threat of declaring China to be formally manipulating its currency to convince China to change. That requires a consistent policy to encourage China to revalue its currency that is pursued effectively over a long period of time, something I am not convinced the Bush Administration has done.

Revaluing the renminbi, by the way, is not something that is unambiguously against China’s interests: revaluing the renminbi (or yuan) would also help China avoid a dramatic expansion in its money supply that is fueling a domestic credit bubble (and rising inflation, now suppressed by administrative measures).

I don’t think there is much doubt that China’s peg is an impediment to effective balance of payments adjustment, and that is keeping its currency low in part for commercial gain. It clearly has more than enough reserves (now over $460 billion, and growing by about $100 billion a year), given that it has almost no external debt and given that China is not going to suddenly liberalize its capital account. China is a major net creditor to the world, yet it clearly is not expecting a positive financial return (in local currency terms) on its dollar reserves – I presume the Bank of China expects a financial loss when the dollar does depreciate against the renminbi, but views that financial loss as a price worth paying for strong, investment and export led growth now. It is true that China is not running an enormous current account surplus – but that is the wrong measure. As I have argued before, a country like China that is attracting 3% of GDP or more in FDI and with little external debt should be running a current account deficit in equilibrium, particularly if it is the midst of a dramatic boom in investment.

That is not to say that China’s willingness to finance our budget deficit cheaply unambiguously hurts the overall US economy: by keeping interest rates low, it helps interest sensitive sectors and supports the value of many financial assets, even as it hurts US manufacturing and regions of the country that depend on manufacturing. But even if the US does benefit in the short-run, the current pattern is unsustainable, and at some point, we will have to starting exporting more/ importing less. Adjusting to put our economy on a more sustainable footing won’t be easy; it will be extremely painful if the government does not reduce its own need for borrowing.

A final point. Treasury is right to note that the foreign exchange rate report is often not delivered on time – that is more often than not a result of the fact that no one cares about the report, and if neither the Congress nor the press is demanding the report, it is hard to get Treasury principals to focus on the report and clear it. I know – one of my first jobs at Treasury was to work on parts of the 1997 foreign exchange report – one of the reports that was never issued (it got wrapped into the 98 report). By the time that report was cleared, it was so far out of data that it was worth issuing. But at the time, there was no real question of currency manipulation (defined broadly as interevention to keep the currency weak for commercial gain) – Treasury was desperately trying to keep Asian currencies from falling further after Asia’s financial crisis. The US, through the IMF, was effectively lending Asia money to help prop up Asian currencies; right now, Asia is lending the US money to help prop up the dollar (and in the process, helping Asian exports). The situation is completely different.

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