Brad Setser

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My testimony on China – and the Bergsten/ McKinnon debate …

by Brad Setser
August 24, 2006

I had the opportunity to testify before the US-China Economic and Security Review Commission on Tuesday – on a panel with C. Fred Bergsten and Professor Ronald McKinnon of Stanford.  

It is quite fair to say that I was the warm-up act for the main card – the Bergsten-McKinnon debate.    

Bergsten believes that RMB revaluation is essential – to help bring the US trade deficit down, to help slow China’s own economy without adding to its current account surplus and to maintain a relatively open international trading system as the US economy slows.   Regular readers (and in August, are there are any others?) know that I basically agree.

Dr. McKinnon, by contrast, believes that any additional appreciation of the RMB against the dollar would be a terrible mistake.   It would compound the mistake that China already made when it broke the RMB’s longstanding peg at 8.28 … and replaced it with what seems to be a crawling peg against the dollar. 


McKinnon’s argument is spelled out in his most recent paper.   RMB appreciation would not necessarily reduce China’s current account surplus.   Sure it would lower Chinese export growth.  But if it slowed China’s economy, it might also slow China’s import growth. If you prefer to reason from the savings and investment gap, McKinnon argues that the savings and investment gap is independent of the exchange rate.   If anything, he thinks change in the RMB would lead to less investment in China’s export sector and a larger Chinese surplus …

But that isn’t all.  Expectations of RMB appreciation, according to McKinnon, would drive down Chinese interest rates.  If Chinese interest rates are equal to US rates and the RMB is expected to appreciate, everyone should want to hold RMB rather than dollars.  The obvious solution here – pushed by Bergsten — is a big initial revaluation that ends expectations of future appreciation.  But that isn’t politically realistic.   Another argument: expected exchange rate appreciation do not have to match the interest rate differential if there are capital controls.   McKinnon’s response: China’s controls are relatively ineffective … since China already has a market economy.   The last point certainly seems a bit over-stated to me. 

Above all, though, in McKinnon’s view, RMB appreciation risks push China into a Japanese-style liquidity trap.  China would enter into an era of deflation.  The low nominal interest rates created by expectations of RMB appreciation wouldn’t lead to a boom, but rather stagnation.  

McKinnon’s argument hinges on an analogy between China today and Japan in the 1980s and early 90s.   China gets “bashed” for its large bilateral trade surplus today.   Japan got bashed in the 1980s.    But when Japan acceded to US demands for yen appreciation, its economy slowed (after the bubble years).    A slowing Japanese economy, in turn, maintained the Japanese surplus.  And pressure for further yen appreciation …  

McKinnon consequently argues that China should resist pressure to let the RMB appreciate.   And, in a change (I think) from his earlier writing, McKinnon also argues that there are good fundamental reasons why the rapid growth of China’s export sector hasn’t bid up prices for non-tradable services and thus led to a real appreciation.    There are lots of under-employed Chinese in rural areas that can be pulled into agricultural jobs.   Consequently, McKinnon believes that China should target an inflation rate below the US inflation rate (which is too high in his view) – something that is consistent with Chinese interest rates that are somewhat below US interest rates and a very modest pace of nominal appreciation.

And if China’s nominal appreciation against the dollar only makes up for higher inflation in the US, well, the real exchange rate remains unchanged.  Despite China’s large and growing trade and current account surplus.    Despite rapid reserve growth.   And despite all the pressures rapid reserve growth – and the associated increase in base money – places on China’s domestic financial system.  

Bergsten argues that yen appreciation played a key role in reducing the US trade deficit in the 1980s.  I think he is right on that point.   Toyota wouldn’t be producing in Kentucky and Honda wouldn’t be a fixture in Ohio if the dollar remained at its 85 highs.

Bergsten also argues that yen appreciation didn’t cause – at least not directly – Japan’s bubble economy.  Or cause the bubble economy to burst. 

According to Bergsten, the bubble economy of the late 1980s came not from yen appreciation, but from the Bank of Japan’s attempt to offset the impact of yen appreciation on Japan’s domestic economy with loose monetary policy.  That loose monetary policy gave rise to the surge in the Nikkei, the surge in Japanese real estate and all the other features of the bubble economy.   The lost decade that followed came from the collapse of the bubble economy, not from a strong yen.    

This isn’t just an American view.   Kuroda has made a similar argument.   Kuroda says that the right lesson from Japan is that it resisted pressure for appreciation for too long –at least in the 1970s – and that it let its bubble economy get out of hand in the late 80s. 

Bergsten argues that Japan would have been better off had it tried to offset the impact of yen appreciation with a bit of fiscal stimulus rather than with a relatively loose monetary policy.   His advice for China is similar.   Combine renminbi appreciation with fiscal stimulus.   Sounds good to me.

This debate has obvious implications for China.   If a burst bubble economy and domestic deflation can only come from RMB appreciation, China is safe so long as it resists (bad) American policy advice.   If a burst bubble economy and domestic deflation comes from excessive money growth, asset price inflation and over-investment, well, China is potentially in trouble even if resists pressure for RMB appreciation. 

Actually, it could be worse off if it continues to resist pressure for RMB appreciation, as that implies continued rapid reserve growth, continued difficulties with sterilization, continued strong money growth, continued deposit growth and a constant battle to keep the Chinese banks from lending out all their surplus funds …

In Japan, loose monetary policy came from an attempt to offset yen appreciation.   China’s current loose monetary policy (partially offset by the use of administrative controls) has stemmed from an attempt to avoid yuan appreciation. 

I tend to side with Bergsten. 

China today isn’t Japan in the 1980s.   It is more like Japan in the 60s or early 70s. And the yen appreciated throughout the 60s in real terms without slowing Japanese growth (Japanese inflation was higher than US inflation).  The yen appreciated in the 70s in both nominal and real terms and Japan’s rapid growth basically continued.     

Japan’s catch-up phase was marked by a real appreciation of the yen.   China’s catch-up phase hasn’t been associated with a real appreciation of the RMB.   At least not since the dollar started to slide in 2002.  

I don’t quite see why stability in the RMB/ dollar matters more than stability in the RMB/ euro now that China trades as much with Europe as the United States.   That is a point that often gets missed in this debate.   East Asia is increasingly part of a world economy.  Not just a Pacific economy.   And on a broad trade-weighted basis, the RMB is far weaker than it was in 2001 or 2002. 

Nor is a strong currency always associated with a domestic slump.   Strong currencies and strong growth often (though not always) go together.   Think of the US in the late 1990s.  Or Europe in the late 1980s.   Hell, Europe right now.  Q2 growth in Europe was rather impressive – and the euro isn’t exactly weak.

That said, I increasingly fear that the investment boom in China has now reached such a scale that there is a meaningful risk that it will end badly – yuan appreciation or not.    China should have allowed the RMB to appreciate v. the dollar from 2002 on.   It didn’t.   That had consequences.   

China may have exported its way into a bubble by following the dollar down.  But that doesn’t mean it will be able to export its way out of a burst bubble and an investment slump – should the current boom every end.  I suspect that China has put itself in a position where it will have to find a way to stimulate domestic consumption once investment growth slows.  If for no other reason than I don’t think China will be able to increase its current 25% y/y export growth should its domestic economy slow.

In addition to reactions to the Bergsten/ McKinnon debate, I would be very interested in reactions to my own testimony.   

My written testimony includes a fair amount of material documenting why I do think the RMB is now significantly undervalued — and why global rebalancing requires decoupling the RMB from the dollar.   I tried to highlight how Chinese exports to Europe responded to the RMB’s massive depreciation against the euro.   Overall Chinese export growth has actually been stronger than the growth in China’s exports to the US. 

Probably because the RMB has been stable against the dollar and has declined against many other currencies …


  • Posted by Dave Chiang

    Hi Brad,

    The U.S.-China Economic and Security Review Commission has a consistent record of hostility toward trade with China. Instead of addressing the Monetary policy failures of the Federal Reserve that has encouraged overinvestment in a housing bubble and a lack of savings among Americans, the commission takes the politically correct avenue of just blaming the Chinese. The United States runs a trade deficit with almost everyone in the entire world, not just China. And China is merely a final assembly point for labor intensive production with component imports from Japan, Taiwan, and Korea. It is impossible to secure totally balanced trade between any two countries in the world given the dynamics of international trade and globalization.


  • Posted by Dr. Dan

    Brad – Another stunning piece from your stable. thanks for sharing the pdf with us. It has loads of good info.

    Given the fact that hiking rates are not doing the trick, how far do you think (an educated guess) China will allow the RMB to appreciate within year end ?

    My second q is, will this RMB appreciation have any impact on $USD ?

  • Posted by HK

    Brad and Dave–I totally agree with Sester/Bergsten/Kuroda and disagree with Chiang/McKinnon. (McKinnon’s prescription implies an explosion of China’s doreign exchange reserves, which is simply unsustainable.) And, the current imbalance between China and the US is so huge that its unwinding must be carefully managed.

    For instance, if the US government openly argues for a significant dollar depreciation to rectify the imbalance, the dollar will collapse immediately (free fall like in 1977-78 and 1985-86) against the euro and the yen, not against the renminbi, and long-term interest rates will shoot up violently. Then, the US economy and with it the global economy will be in a deep recession.

    The housing bubble in the US is already bursting, and the Chinese real estate and investment bubble is on the brink of bursting. Any shock in the financial market will bring about a deep recession and serious deterioration of balance sheet, creating financial crises in the world.

    The most appropriate policy mix for the US is the maintainance of loose monetary condition and significant tightening of fiscal policy. China should do the opposite; tightening monetary policy and loosening fiscal policy, while allowing the renminbi to appreciate steadily. It is absolutely necessary to strengthen capital inflow controls. (Temporary banning of FDI and portfolio inflows may be necessary).

    Even though well managed, the unwinding of the imbalance between the US and China would be painful for the two countries; so that political leaders in both countries are just postponing inevitable adjustment. At this stage, I am pessimistic about the possibility of an early and well managed unwinding.

  • Posted by Charlie

    The RMB needs to appreciate vs USD. I think both the US and China agree on this. The real issue is how fast to appreciate. I think about 5%/yr until the trade deficit stabilizes is about right. The rate can be adjusted up or down depending on current conditions. I also don’t buy the Japanese comparison in the 80’s. Like Brad said, the Yen appreciated for decades. Not just in the 1980’s. If anything, the plaza accord help soften the eventual landing of the Japanese economy.

    Contrary to Dave Chiang, I think China had as much to do with the current housing bubble as the fed did. China buys a lot of mortgage backed securities. China played a huge role in keeping mortgage rates in the US low.

  • Posted by bsetser

    HK — you are in the Bergsten/ Kuroda/ Setser (no equality implied in the list, I am the junior member) camp! We all also advocate tightening inflow controls by the way. Bergsten and I both embraced inflows controls in the questioning as a means to limit speculative pressure during gradual RMB appreciation.

  • Posted by Gcs

    brad nice analytic trail

    japan is indeed on many chinese minds
    these days

    but as you point out
    lining the two up properly
    for comparison
    takes some careful thought
    throwing around crude analogies
    serves only to bums rush the verdict

    i agree with one thing

    nothing inevitable about bubbles
    stagflation etc etc
    just because the rmb starts today
    on its large rise against the dollar

    if the big boys take the plunge
    one hopes they use the fisc levers
    as u suggest to counter the domestic demand effect
    of the export slow down

    a key diff from japan the one i believe that has
    kept us from putting the screws to china

    the penetration of china’s industrial and commercial economy by us trans nats
    and the hope for same in its financial sector

    north am trans nats were not by enlarge
    of the trade profits associated
    with low ball yen of the 70’s and early 80’s
    as they now are
    with low ball rmb

    profitably low prices
    for north headed exports are at least partly tied to the low ball rmb
    and listen it don’t hurt
    when you can buy “production factors”
    on the main land so cheap either
    something very few american trans nats
    could do in japan between 65-95

  • Posted by bsetser

    gcs — yes, that is an important difference. it goes a long way toward explaining the different political economy of 6% trade deficits now and 3% trade deficits in the 80s

  • Posted by Guest

    Apologies if this is off topic or a dumb question, but thinking back to one of Volcker’s talks, is there not some merit to the idea that, in the ideal world, a ‘successful’ RMB revaluation requires the completion of a great many steps in-between – including agreement and a better alignment among the Asian bloc – and co-ordination with other increasingly significant trade regions such as Latin America, Africa and Russia…?

    “Backed by the economic muscle of Japan and China, a new free-trade zone representing almost half of the world’s population could soon be emerging in Asia… The free-trade idea, spearheaded by a Japanese promise of ¥10-billion ($95-million) for a detailed study of how to make it work, won support yesterday from the Association of Southeast Asian Nations (ASEAN) at a meeting in Malaysia…”

  • Posted by ReformerRay

    I said I would desert this web site cold turkey, but I cannot. Too much good stuff on this post.

    The Mckinnon piece has much interesting data. I do agree that the Japanese – U.S. relationship should be more carefully investigated and understood.

    He does a lot heavy lifting to try to explain how it is that the large Japanese trade surplus with the U.S. remains constant throughout all this period, despite all the ups and downs of exchange rates. I can’t really evaluate his efforts. I do suspect the existence of factors he doesn’t consider, such as the policy of the Japanese government and society at large to maintain a trade surplus with the U.S. as a priority objective.

  • Posted by Joseph Wang

    Chiang: The central bank of Mainland China is the People’s Bank of China. The Central Bank of China is the central bank of Taiwan.

    I do think that an RMB appreciation is a good thing overall, but I’ve always disagreed with those in favor of a “big bang” appreciation.

  • Posted by Dave Chiang

    According to German Economist Dr. Richebächer, Austrian Economic theory recognizes that the excessive credit expansion has many impacts on the financial markets and the real economy.

    1. Asset prices, including houses, inflate.
    2. Savings rate disappears
    3. Trade Balance goes negative
    4. Capital Investment dries up
    5. Wages and employment drop

    Are not these the economic symptoms from the maladjusted US Bubble economy?

    Yet, Chairman Ben Bernanke is on official record stating that the Federal Reserve is ready to stimulate the US Economy by “dropping money from helicopters”. To mitigate damage caused by a collapsing Housing bubble, Ben Bernanke will have to recall the US Airforce fleet of Jumbo C-17 Cargo Jets from Iraq to bomb the cities of the United States with freshly printed $100 bills.

    Its not a stupid question to ask if there are any US federal regulators or Economists responsible for anything in the US economy today?


  • Posted by bsetser

    i tend to think that RMB revaluation would trigger a host of other coordinated moves … so i am not sure there needs to be coordination in advance. all asian economies could revalue against the $ without changing the internal parities inside Asia, if that is the concern. Building an alternative to “everyone pegging or managing their exchange rate v. the $ and thus v. each other” would take more time, but it isn’t necessary for a revaluation.

    i also suspect a revaluation/ slowdown in Chinese export growth is necessary to prompt China to get serious about its internal rebalancing — i.e. seriously spurring consumption as an alternative to an export and investment (including in the export sector) boom.

    finally, global rebalancing does require a host of changes — some in markets, some in policies — and i do think a bit of coordination would help. but if everyone recognizes directionally what they need to do (surplus countries stimulate domestic demand, deficit countries restrain demand), formal coordination may not be needed.

  • Posted by Dave Chiang

    To Brad,

    While the People’s Bank of China has been somewhat supportive of a revaluation, the Chinese Ministry of Commerce has just issued a strongly worded whitepaper warning of serious consequences of a major RMB revalution. The Whitepaper warns about the potential of massive unemployment from the loss of labor intensive jobs and potential political unrest threatening the social stability of the nation. Under those conditions, the State Council will more than likely maintain the status quo. Among the top leadership of China, there is continuing debate over a currency revaluation. More than likely, the Chinese RMB will gradually appreciate at a rate of between 2 to 3 percent per year. Whatever the Washington Consensus thinks of China’s monetary regime doesn’t count; economic decisions are solely based upon internal domestic considerations.


  • Posted by http://nihoncassandra.blogspot


    You are suggesting that a fundamental change in behaviour – from national parochial interest to a form of coordinated cooperation that requires sacrifices from large powerful segments of the polity in the US, China & Japan. While necessary, and I oh-so-hope we can pull it off, I would not bet on it as motivations necessary to overcome the domestic opposition in all 3 countries is likely to be mustered only AFTER the onset of crisis. To me, that means more twiddling until the markets eventually force the issue, and front-run the PBoC or large reval, which they will the more blood they smell. And we will all be worse off for not pre-empting the unfolding of events when it was perhaps manageable.

    Dave Chiang vilifies the Fed as “the cause”, and while he is not altogether wrong, both PBoC and BoJ & MoF must accept their share of the blame for they are certainly culpable as primary enablers, be it ZIRP, cynical intervention, or unrepentant reserve accumulation. Indeed, the PBoC & BoJ could have sent “shots across the bow” many times before as a wake-up call to US fiscal policy, but instead the BoJ intervened in the FX mkt and bot USDs pushing it in the OPPOSITE direction while the PBoC continued selling Put Options on US Treasury bonds till bond vol dropped to all-time lows. What other better signals of tacit policy approvals (thus enabling) could there be??!?

  • Posted by ABC

    Mc Kinnock does raise an important point in that even though nominally the yen/dollar exchange rate experienced massive appreciation, due to its deflationary effect the real exchange rate was at 1980 levels by 1995.

    He also points out the risks of a ZIRP liquidity trap that do seem quite appropriate to the Chinese situation. Their interest rates at under 2% are bound to experience downward pressure.

    Further, he points out that once an appreciation is an established fact, and the trade surplus has not decreased, there will be renewed calls for appreciation, a point I have sympathy with. It goes towards the fixed versus pegged exchange rate setup. One is a result of a monetary rule, the other is subject to massive speculation.

    I am inclined to agree with Dave Chiang on this. Fiscal rectitude is the responsibility of each nation. A significant portion and arguably the unsustainable portion is driven by continuous budget deficits from a profligate administration.

    I must ask is there an elephant in the room? Does the US really want to start paying for holding military bases in 130 countries including waging war in two at the moment? It was partly a monetary expansion to fund increasing interventionism, not to forget Vietnam that caused the collapse of BW I. There does appear to be strange parallels. Plus one can hardly claim that oil exporters surpluses are due to exchange rate pegs, when it is rampant speculation based on geopolitical tension and ridiculous monetary growth that is fuelling the price.

  • Posted by Gcs

    “the policy of the Japanese government and society at large to maintain a trade surplus with the U.S. as a priority objective”

    for what its worth
    i don’t think the politbureau boys
    are nearly so neo mercantilist
    as the japanese were/(are?)

    one recalls resource poor japan’s
    ” dire need ” for an export trade
    big enough
    to pay for vital raw items like oil ore and lumber

    china is
    emerging from a long long long history
    of quite the opposite
    of “inwardness of development ”

    the party bosses
    really want world class technical mastery
    they think (for now)
    export max = technical advance max

    they export
    not to “conquer”
    foreign markets
    or to maintain a “safety edge” surplus

    in my opinion
    even its resource reach out
    is “transitional”
    but thats far more contravertable

    so if the trade deficit
    is incidental
    its shrinking won’t
    by itself cause the sorts of silly
    restrictiveness japan still plays with

    but let me suggest
    imports to feed the fantasy cravings of the new middle class
    will be sharply controled
    only production enhancing imports are green lighted
    and i don’t see that changing soon
    other wise
    only agri imports might be allowed
    to rise faster then industrial exports

    greater efforts to expand exports
    simply on their own account is not
    part of the party’s dogma

    if growth max required more imports
    or at least
    a period of faster import growth
    then export growth
    so be it


    oh ya

    the idea the party can’t macro control
    the economy any more is
    not something i’d try betting on
    when it comes
    to currency and credit flows
    it might be the hope of wall street but it ain’t IMO
    as yet a reality

  • Posted by Gcs

    mighty joe
    oh ye of the higher maths

    i hesitate to write this
    as with hk and dc
    i operate
    without official recognition with u either

    but what the hell…

    i agree “big bangs ”
    are out
    but this so far
    is “no bangs ” at all

    crawling peg is my vote too

    what say u more specifically

    what is the optimal crawling rate ????

    what sort of relative interest and price change rates ????

    put a number to these for me
    and should the crawls climb
    be smooth and just too slow for spec profits
    or full of jigs and jags
    to burn the specs
    what fun
    this is real rat ex
    super calc
    hammer time here

    and where would you think
    the parity might be

    the stopping point
    the point of balance
    between the us dollar and chinese yuan

    where and when
    can we expect to drive that silver spike

  • Posted by PC

    Great post. Your objective presentation of both sides of the agrument is highly persuasive (in favor of your argument that the RMB needs to appreciate).

  • Posted by algernon

    Dave Chiang,

    China’s PBC is just as guilty as the Fed has been of the sins you rightly accuse the Fed. That part of supporting the Yuan peg which is unsterilized has resulted in galloping money supply growth–19% in the past 12 months. As an Austrian, you should appreciate that they are distorting the structure of their production just as the US has done.

    China’s extraordinary saving rate may be their saving grace. But I doubt it. When US consumption diminishes, China will probably discover that it is geared up to produce the wrong stuff. AKA, misallocation of resources.

  • Posted by DOR

    China is not Japan in the 1980s, nor Japan in the 1970s, nor Japan in the 1960s. The differences are far too numerous to go into here, but they are both fundamental and compelling.

    “Bergsten argues that yen appreciation played a key role in reducing the US trade deficit in the 1980s. I think he is right on that point. ”

    In nominal terms, the Yen depreciated by 1% a year between 1981 and 1985 (from Y226.7:US$1 to Y238.5:US$1) and then rose by 10.5% p.a. in the next five years, to Y144.8:US$1 in 1990.

    In the first half of the decade, the US merchandise trade deficit averaged US$73.3 billion a year. In the second half, it averaged US$132.1 billion a year. From this, how can Bergsten (and you, Brad) conclude that the appreciating yen played a key role in reducing the US trade deficit in the 1980s?


  • Posted by Dave Chiang

    Reply to Algerion,

    Fiscal and monetary rectitude is the responsibility of each nation including both China and the United States. The Central Bank of China is certainly culpable for monetary distortions that have led to property asset bubbles in Shanghai and Beijing. In the past month, credit has been significantly tightened and short term capital gain taxes have been imposed on Real Estate speculators. Luxury property prices in Shanghai have plunged 10% in the past couple weeks alone. The People’s Bank of China takes full responsibility for that nation’s monetary regime. Likewise, the Federal Reserve should step up to the plate and take full responsibility for the massive credit-driven Housing Bubble in the United States that has distorted markets along both the east and west coasts, accounting for 50% in dollar property values of the nation.


  • Posted by Stormy

    Responses to both sides:

    Bergsten and McKinnon fail to see the huge difference between Japan in the 80’s and China today, in terms of the size and nature of the cheap labor, as well as savings mechanisms. Unless the revaluation is very large and labor shares in the profits, China will not become a consumer nation.

    Furthermore, before Chinese labor even remotely approaches consumer levels, FDI will move elsewhere—Vietnam, India, and other developing nations.

    Furthermore, if China’s exports become more expensive, then that alone will push the U.S. into deep recession well before exports here have a chance to develop, drying up already parched U.S. investment in the companies remaining here. Additionally, a falling dollar is going to accelerate the rising cost of energy in the U.S.

    There is simply no quick way out of this dilemma. I suspect that we will have our recession, but the usual U.S. recovery will be very minor, much like a sled moving down a series of ever-smaller hills until it reaches rock bottom. The global economy will shrink; I don’t see any nation large enough or any group of nations, European or otherwise, stepping forward to being the world’s consumer.

    Chasing cheap labor and other profitable goodies is going to have a steep price. All the normal economic theories are going to need serious revision when all this has played out in the next ten years.

  • Posted by touche

    “Chairman Ben Bernanke is on official record stating that the Federal Reserve is ready to stimulate the US Economy by “dropping money from helicopters””

    If he realizes the necessity of this action, he’s a smart man. This is the only way to escape the quicksand of debt that consumers have accumulated in the US. I prescribe 10% inflation for at least 10 years and elimination of the mortgage interest deduction. The alternative is even greater misery drawn out much longer.

  • Posted by Anonymous

    The world is on a collision course with rebalancing. The central banks and governments have worked to develop and sustain a stable disequilibria, the maintenance of which becomes more difficult with each passing day. Any change to the current system invites an every man-for-himself crisis. China, and the world, are in an unsustainable bubble.

    The true social cost of the massive shift in production to Asia from the US and Europe is lying just below the surface like the Titanic iceberg. There will be a backlash against the whole idea of lopsided imports from China while American families are without jobs. The housing bubble was a cynical, short term diversion that has provided enough domestic cover so that the trans nats could establish a parallel production/supply chain in Asia. The white elephant in the room is that Asia has no internal personal consumption function and is attached to exporting to the US like a leech.

    When the bubble breaks, China will pull out all stops in a deflationary death spiral to maintain export employment at all costs. The US will elect a government that will intervene to limit imports, pushing Asia toward collapse like the late 90’s. Ultimately, the dollar will not drop as far as it would in a free trade world for the same reason it has not yet fallen. The gold standard is the US middle class which the current government has weakened but not broken. Although corrupted by the federal reserve, the dollar is less corrupt than the RMB, yen, etc. Before it is all over, we are likely to see a political backlash against the financial and banking industries, the fed, the presidency, and congress.

    China, and Asia, should be most concerned with stimulating internal consumption and prepare for import limits in Europe and the US, something that should have been done long ago.

    The US needs to stabilize it’s own currency and begin limiting excessive imports of manufactured goods through a system of “market access taxes” or outright numerical limits. I am all for free trade. The current trade situation is a corrosive cocktail of deflationary doom that has been established over the past decade. Free trade it is not. Greenspan and company imorted the Japanese bubble economy with soy and we better batten down the hatches, now. The forex market is corrupt and will get worse before it gets better. The underlying assumptions of Adam Smith’s work was organic growth, something that is in truly short supply in this manipulated world.

  • Posted by Movie Guy

    One thing is certain – all three – Bergsten-McKinnon-Setser – can’t be right.

    Who will get it wrong?

    And just how much older will I be when this finally plays out?

    I laughed when China switched to the magic black box. And it has performed its intended magic.

    If the magic is removed, where do the cards fall? I wouldn’t know…not with any certainty.

    I don’t know that all of the magic can be scrubbed away. I doubt it. If true, which of the three positions is more likely to occur? Isn’t that more to the point?

  • Posted by Movie Guy

    One thing is certain – all three – Bergsten-McKinnon-Setser – can’t be right.

    Who will get it wrong?

    And just how much older will I be when this finally plays out?

    I laughed when China switched to the magic black box. And it has performed its intended magic.

    If the magic is removed, where do the cards fall? I wouldn’t know…not with any certainty.

    I don’t know that all of the magic can be scrubbed away. I doubt it. If true, which of the three positions is more likely to occur? Isn’t that more to the point?

    Movie Guy

  • Posted by HK

    The late Schumpeter differentiated “vision” from “analysis” in economics. Any economist must have vision as well as analysis. If he or she has vision but no analysis, that could be only dream or immagination without substantiaton. If he or she has analysis but no vision, it would be useless and vacant.

    Now, although I do not agree with McKinnon or BW2 adovocates, at least they provide their analysis which could support their vision. (I must say that McKinnon is far better than the three economists who originated BW2 thesis.) On the other hand, many, including those who argue against s significant renminbi appreciation on this website, have not provided any coherent analysis supporting their vision.

    I do not think any new theory is necessary to explain the current global imbalances; why they appeared and how they would evolve in coming years depending on the policies to taken by major countries, including the US and China. (On this point, McKinnon and the adovocates of BW2 will also agree, though their vision may be very different from mine.)

    The key question is whether the system adovocated by McKinnon and BW2 supporters is sustainable or not. I assume it unsustainable, because it implies indefinite accumulation of foreign exchange reserves in China and subscribing countries. A more sustainable and likely outcome is real appreciation of the renminbi and other currencies against the dollar, either through nominal appreciation or domestic inflation.

  • Posted by Anonymous

    And Movie Guy, just what is the point of your arcane double post? Magic Black Box=?

  • Posted by Dave Chiang

    From Bloomberg News Agency, the Federal Reserve still refuses to accept any responsibility for the massive credit bubble that has distorted Housing markets from coast to coast. Instead, the Federal Reserve mantra has been to blame the monetary policies of the Chinese, blame the Japanese, blame the Arab Gulf states, blame the Russians, scapegoat someone else. The Federal Reserve and most of the economics profession continue to completely ignore the dangers of Asset Bubbles.

    ” The first time Ben S. Bernanke appeared at the Federal Reserve’s annual mountain retreat seven years ago, the Princeton University economist’s message urging a hands-off approach to asset prices sent his reputation soaring.

    “Bernanke has maintained his academic view that asset prices are indicators and not something to target,” said John Silvia, chief economist at Wachovia Corp. in Charlotte, North Carolina.

    “The Fed doesn’t really have any better information than other people in the market about what the correct value of asset prices is,” Bernanke said in the appearance at Princeton, where he was a professor before becoming a Fed governor in 2002.

    Bernanke’s 1999 Jackson Hole paper gave him media exposure around the world, earning mentions — and some criticism — in outlets including the Economist, Financial Times and Chicago Tribune, which examined whether such a policy was appropriate for dealing with the then-soaring stock market.

    The housing downturn risks eroding the confidence of consumers, whose spending accounts for most of the economy. Housing accounted for more than half of U.S. economic growth over the past three years, according to Merrill Lynch & Co. estimates. “

  • Posted by MTC

    Uh-oh, sign of the onset of the Apocalypse: PC compliments Dr. Setser’s posting.

  • Posted by Dave Chiang

    China may Shield Asia From a U.S. Slowdown

    ” It would seem to follow that if the U.S. slows significantly, so does Asia.

    Not so fast, says David Carbon, an economist at DBS Bank in Singapore.

    Carbon argues the impact of a U.S. slowdown will be “less than one would think, and certainly less than in the past.” Yet it’s his take on Asia’s exponentially increasing role in the global economy that may come as a surprise to many.

    The basic gist of Carbon’s argument is that in five years’ time, domestic demand in Asia will outstrip that of the U.S. The reason: Asian economies are booming, rapidly integrating and their young, growing populations will support strong growth.

    “We’re definitely on the cusp of a big handover in terms of who drives global growth,” Carbon says. “It’s looking us square in the face. Funny nobody sees it.”

    – Bloomberg News Agency

  • Posted by bsetser

    DOR — I meant 80s broadly.

    the very strong dollar of 84/85 combined with the US recovery from the 81/82 recession drove up the US trade deficit in 85/86/87. Lags are important here. I was referring the dollar’s post plaza fall and the lagged impact on the trade deficit, which was quite significant. See the deficit in 89/90 …

    Anonymous: I fear you may describe the likely course of the world economy.

    “When the bubble breaks, China will pull out all stops in a deflationary death spiral to maintain export employment at all costs. The US will elect a government that will intervene to limit imports, pushing Asia toward collapse like the late 90’s.”

    There are two bubbles here. The bubble in tradable goods investment (and real estate) in China, and the bubble in us housing. The housing bubble is breaking first.

    PC — I am stunned, but thanks!

  • Posted by Dave Chiang

    Now the Housing bubble is over. Ben Bernanke, think quick and find another asset class for us to believe in and exploit before its too late…

    Stock market bubble, Real estate bubble, what Bubble asset class is big enough to mitigate the effects from the last bubble. Is this how Federal Reserve monetary policy operates?

  • Posted by Joseph Wang

    There are two China thinktanks in the US government. The US-China Economic and Security Review Commission (USCC) and the Congressional Executive Commission of China (CECC). The CECC has become something of a clearinghouse of information on Chinese human rights and rule of law issues, and they are taken rather seriously.

    No one in any position of authority takes any of the recommendations or reports that the USCC has issued with any degree of seriousness, since in the past they’ve displayed a shocking amount of ignorance about economic and trade issues, and a pronounced “dragon slayer” bias to the point that they have very little credibility.

    It is good to see that they are trying to fix this deficiency.

  • Posted by Joseph Wang

    Real estate makes up a modest fraction of bank loans in China (15%). Every real estate loan in China could go bad, and it still wouldn’t be as bad as the mess in the mid-1990’s. Most of the loans that the banks are making are to SOE’s for working capital, and as long as the SOE’s are profitable, the total amount of bad loans should be managable.

    It’s a bit too late to argue about whether China should depeg or not. It’s already depegged. Also looking at MacKinnon’s paper, China’s economy is so far from a developed market economy that I don’t think that any of his models even begin to make any sense.

    The other thing is that I suspect that the views of the Chinese leadership and Western economists are starting to converge between there is a linkage between Chinese “underconsumption” and the big problem that the CCP is worried about, which is rural incomes.

  • Posted by Dave Chiang

    From Bloomberg News Agency,

    ” Counting retained mortgage portfolios, MBS holdings, and residential real estate construction loans, U.S. banks have record exposure to residential real estate — something around 60%. ”

    ” The inventory of unsold homes in July rose to a record high of 3.86 million. At the current sales pace, it would take 7.3 months to exhaust that overhang. That is the longest period to exhaust the supply of home since the spring of 1993. ”

    My comment: The collapse of the Housing bubble has only just begun. The US banking system doesn’t stand an ice cube’s chance in hell.

  • Posted by Gcs

    what mighty joe
    no numbers!!!!!

    i give up

    the jw dc hk block agin me is too solid
    is their a common denominator

    if so i can’t find it

    and god knows brad
    ever the decent host
    can’t be expected
    to carry the ball solo

    as reformer ray
    must now realize
    we each and all
    need commenter to commenter interaction
    to thrive here

    hence forth i’ll send my messages
    directed toward those noble three
    riding the wave
    a higher seriousness
    milk bottles
    — with a certain melancholy —
    into the broad and foaming atlantic

  • Posted by bsetser

    for the first half of the year, the crawl was about 1% — too slow in my book. China wants (it seems) to keep it less than the interest rate differential (@ 3% on deposits) to discourage hot money flows, which means keeping it right at the inflation differential (for now) which is also too slow in my book. Something above 5% seems right to me, but that needs to be sustained over several years. And there is an obvious problem with speculative flows in the face of such an anticipated increase.

    I don’t think the PBoC has solved that conundrum. Which is why it wanted a bigger initial move … I also would like to see Chinese inflation above us inflation with higher Chinese inflation contributing to the real appreciation.

    And 5% v. the dollar itself might be too slow if the dollar is falling v. the euro.

    Any other views? GCS is right — this cannot be dialogue between me and all of you … at least not on a sustained basis!

  • Posted by Gcs

    “To me, that means more twiddling until the markets eventually force the issue,”
    i’m of course no way aware of who wrote this

    but its part of a very thoughtful comment

    however may i suggest
    it is precisely because “the markets ”
    can’t ever alone resolve this matter
    that it persists even till today

    the cb culprits behind this ugly asymmetry
    have the means among themselve
    to thwart the markets
    and they have repeatedly
    when co ordinated

    ie private profit motivated
    moves can’t brake us out of this imbalance
    only politically motivated
    cbs can

    this crisis abrewing
    will remain essentially
    the handy work
    a multi national political ” cb cartel ”

    til this cb cartel brakes down
    or changes direction ala plaza
    and i see little evidence
    of either happening right now

    though obviously
    i hope for
    a major shift away from bwII
    the trans nat politico economic
    prosperity loop consensus
    and soon

    since that is the only force imo
    that can reconfigure
    these co ordinated
    cb actions
    so we move toward global balance
    not away from it

    don’t hope for a brake down in this co ordinated
    even the growing imbalance is better then that

  • Posted by Gcs

    brad thanx

    my thought
    first off

    don’t drop the admin financial controls
    gentlemen not till you approach parity
    (parity not trade balance)

    if you want steady but galling to hot specs

    try to have some combo of
    three %/two% or two %/three %
    lower interest / higher inflation

    needless to say
    the chaps seem to find inflation resets freaky
    but if they want to do it smooth
    isn’t a net 5 crawl rate
    just at best barely enough ???

    i’d kick it off with a 10% surprise up front
    but hey i’m wild as the typhoons of the south sease

    since i figure the rmb must double against the dollar
    ie fall to 4 to 1
    at a steady eddie
    that will take 12 years or so…..
    maybe at
    todays traffic speeds
    thats too slow

    look at the pile up now

    in which case
    my suggestion
    hit “the market”
    with some serious jumps
    and surround each one
    with so much gibberish
    even greenspan will be envious

  • Posted by Joseph Wang

    Inflation is bad since it discourages long term savings, and faith in the currency, and is it very unsuited for the type of fine tuning that is necessary. The trouble with using inflation as a lever is that the social consequences are very hard to undo, unlike other levers.

    I’d much rather China have low inflation and capital controls, than to have moderate inflation and no capital controls. I don’t think it is possible to predict what China will do over the course of five years since a lot of it depends on what US fiscal and monetary policy is. If for example, budget deficits go down, that will reduce pressure on the RMB. It’s really a delicate dance here, in which neither the United States or China can act without considering what the other side is going to do.

    There’s no way I can imagine China going into a deflationary spiral. There are just too many untapped sources of demand, and too many mechanisms for boosting demand.
    Also, you can confuse the speculators by putting in a random volatility into the exchange rate. As long as the risk-adjusted interest rate is higher than what else is out there, you aren’t going to trigger capital inflows.

    My preference would be stable prices in China, with the exchange rate moving up or down in order to maintain balance.

    Chiang: I don’t think the US banking system is that fragile. First of all, I distrust any conclusions based on one number. Second, what matters is the likely default rate, and even in very bad recessions, the forclosure rate for mortgages isn’t that high.

  • Posted by Joseph Wang

    One other note. There is a blind spot I’ve noticed in international economists. Once one establishes that may be a revaluation is a good thing, then the precise details of *how* to go about doing this without triggering a crisis requires knowledge of how currency markets work, which isn’t the strong point of the economists.

    It appears to me that the Chinese leadership decided about a year ago to revalue, and right now the constraining factor is how to engineer a drop without causing a currency crisis, so I think that economists who have argued that RMB needs to be revalued have won the argument, and the experts on what China should or should not do at this point are currency traders.

  • Posted by Gcs

    jw very astute

    as usual
    i agree

    except on one key point

    “Inflation is bad since it discourages …. faith in the currency”

    not if the currency is seriously under valued
    it just makes expectations of
    that problem less of a problem

    but in general i agree
    inflation is not fine tune able

    and you did hint at what i find deeply interesting

    the fool bluff and cause to stumble the specs policy
    of jumps jerks and springs

    however it certainly can at least be kept neutral
    ie chinese inflation using us inflation as a target floor not ceiling

    and this line of yours :

    “There’s no way I can imagine China
    going into a deflationary spiral.
    There are just too many untapped
    sources of demand
    , and too many mechanisms
    for boosting demand”

    can’t be repeated enough
    so long as the party bigs are prepared
    to use them
    fully enough

    and to me this is true
    of wage price spirals too

    given the limitless supply of under employed
    low productivity employed labor

    but that claim
    has an unorthodox theoretical aspect behind it
    where as
    the demand levers point you make doesn’t

  • Posted by Gcs


    i agree on your add on point

    here to me is the key
    the control of the forex by the cb

    the risk can be greater the wider the policy range

    if china is under huge reval pressure
    the jumps become more likely

    the jumps need to start now
    to keep the reval cries down

    my experience sez
    err at least once to the side of over boldnessnot a post deng party characteristic
    you can get away with almost anything once

    in all this
    the threat and hope
    stiglitz export taxes
    needs to be kept floating
    over the heads of both the trans nats (threat)
    and the schoomerites (hope)

    of course restraints will serve
    but they are corruption prone
    the public purse doesn’t reep the benefits
    now captured as super profits by the export traders

  • Posted by Written by http://nihoncassand


    The Hunt’s had succeeded in their Silver corner in a picture-perfect manner, only to learn too late of The Golden Rule: “Do Not Bet Against People Who Can Change The Rules of the Bet”.
    I believe there are two reasons hedgies haven’t torpedoed the USD & the Bond for lord knows they’ve successfully taken down less sickly prey: 1=PBoC & 2=BoJ. That doesn’t mean they haven’t bet against them, taking bits of flesh here and there, and in the process, diminishing the USD by 35%, and bonds by 15%. Patient as they are it’s driving them insane: they can smell blood, but “they” are haunted by the two seemingly immovable CB obstacles. It may not be overtly so, but the herd knows this to be true: the Macro guys know it ’cause there’s still a “bid”; CTAs know it ’cause they keep getting whip-sawed and stopped out by someone as clever if not more so than Mr Yen himself, Dr. Sakakibara.

    So can the current regime continue to sustain nips here and there? Won’t the regimes divergent inertia eventually create more compelling opportunities for the “kill”? We are seeing the picadores & banderilleros entertaining the crowd. More “twiddling”, (despite Brad’s laundry list in his Testimony) will percolate stagflation, along with continued commodity price rises, accumulation of reserves, and eventually the dreaded wage-price spiral, currently conspicuous by its absence as Gcs has noted on many occasions [NOTE: My local bank has just begun posting its jobs in the local rag with the largest, boldest fonts being the increasing 000’s of $$$ – though admittedly its not Detroit].

    I agree that the markets will have some difficulty moving the PBoC & BoJ, joined at the hips as they are, ceteris paribus. They are not pushovers like the BoE was, and in any event the Chancellor of the Exchequer and his government weren’t really on board anyway, and the stakes were not THAT high in retrospect.

    But as stagflation percolates, so things will change. And each change will be more inimical to the staus quo, diverging from sustainability as it is. Each will create new challenges that defy solution such as further energy price rises that will eventually eliminate the surplusses of the neo-mercantilists, leaving the them as a type of “estoque” in the hands of the oil exporters, who are far more mercenary than America’s current benefactors. Or what will happen when CPI & PPI continue to levitate, blowing out all manner of US Federal Budget indexation, not offset by real growth?

    I wish no for systemic implosion, but I believe that when the markets succeed in taking it [BWII] down, it will be far more disorderly, and with far greater dislocations than imagined, for Americans, Chinese, and Japanese alke, than any of MacKinnons fears, or the fears of the Left with respect to a managed revulsion’s impact upon labour in the West.

  • Posted by Gcs

    nihoncassand :

    ” believe there are two reasons hedgies haven’t torpedoed the USD & the Bond for lord knows they’ve successfully taken down less sickly prey”

    the imperial dollar is not sickly

    its just a Catherine the great type ruling currency

    i love the notion the market specs can
    nip away and worry the systems regulators
    till the front brakes down

    like spoiled kids

    but i got to tell you
    i think the cbs’
    just change their minds when they change their minds
    for their own collegial reasons

    most of the time that is

    when the main players are acting collegial

    the brit pound god rest its imperial past
    being the victim of consensus change
    at least eight times
    since the london blitz
    of 1940

    their home town teameach time
    the necessary dive
    into a lower poundage pool
    as if its the briar patch
    for brother rabbit

    despite Sorosian reps to the contrary


  • Posted by Movie Guy

    And Movie Guy, just what is the point of your arcane double post? Magic Black Box=?

    Written by Anonymous on 2006-08-25 01:34:08

    The double post is because of a problem with the web site last night.

    The magic box was referring to remarks I made long ago on Brad’s blog, in fact only a few days after the decision was announced, regarding China’s switch to a currency basket, the components and relative values were not disclosed. Hence, I properly named it the magic black box.

    Brad, DOR, and others know what I am talking about.

    The likelihood that the level of adjustments desired by some in the West will be accomplished in a disorderly fashion (abrupt) are probably zero. The possibilitiy that currency movements on the order of x% per year occurring might happen, but the incentives to make those moves may or may not be enough.

    As far as I can tell, magic still rules.

  • Posted by bsetser

    GCS — I have no problem with a surprise 10% move, but I have given up hope that it is going to happen (unlike NRoubini, who still believes … )

    J. Wang. 2% inflation in the US v 3% in China seems more resonable to me than 3.5-4% in the US and 1% in China … I don’t want inflation to get out of control in China. But i wouldn’t mind a bit of a cushion v. internal deflation. And a bit of a contribution to real appreciation from inflation differentials, rather than having inflation differentials work against real appreciation. But most of the heavy lifting has to come from nominal RMB appreciation.

    incidentally, do I count as an economist, a trader or something altotgether different in your book?

  • Posted by Anonymous

    I am new to this blog and have read it with interest. I don’t understand the arguments. I am trying to understand the big trends you are discussing.
    In less academic terms, would you all be saying:
    1) in order to extend US demand for its exports, China has been buying US bonds (keeping US borrowing easy and the value of the dollar ‘high’ … or at least somewhat stable);
    2) China will continue to prop up the dollar until it can sufficiently develop local appetites for its goods (and China will eventually, if it has not already, ask the US to sing for its supper);
    3) China keeping its currency ‘tied’ to the dollar staves off speculation on China’s currency, preventing a more unruly domestic economy ( … not to mention the political power that it has accumulated)??

  • Posted by Gcs


    your three points are all headed in the right direction
    get any closer to the mark
    and you’ll be an economist
    be warned
    its worse then a werewolf

    if by “political power”
    you mean the party center
    that has been in slow decline for years
    but it’s “will”
    can still be decisve
    when it has to be

  • Posted by Anonymous

    Thank you for your eply, Gcs.
    I was thinking more internationally than domestically. I wouldn’t have any idea how to look at political power within China, especially given — as one of the other posters pointed out — that I don’t speak/read Mandarin.
    It would seem to me that the longer China ‘agrees’ to support the dollar, then the more influence it amasses on the US’ and other countries’ decisions. And maybe the potential of that influence has more power than if/when it would when exerted outright … which may be another reason — more of a meta-reason — to keep propping.

  • Posted by Laurent GUERBY

    “replaced it with what seems to be a crawling peg against the dollar”

    Hey, looks like the hypothesis I expressed on this blog a few weeks ago :).

    What’s wrong with 2-3% appreciation a year if no shocks happen outside China (eg: no hard landing for USA economy – if it happens something will likely be done IMHO) ? Slowly rebalance currency portfolio of the central bank and that’s it. At 10% GDP sustained growth differential per year, China needs 15 years to reach France per capita GDP PPP, so there’s no hurry : 15 years at 2% per year means that China will reach a fair FX value (no reserve growth to maintain “crawling” peg) somewhere in between with 100% probability (where peg can be abandonned and policy switch to “normal” central banking).

    If PBoC workers care about chinese people they look at the 15 years picture each morning when coming in the office, not at the hourly picture economists from richer economies are focused upon.

  • Posted by http://nihoncassandra.blogspot

    “If PBoC workers care about chinese people they look at the 15 years picture each morning when coming in the office, not at the hourly picture economists from richer economies are focused upon.”

    If PBoC workers care about Chinese people, they will would do their utmost to prevent systemic breakdown. Though I have no answer(s) other than those Brad has proffered, the question might be simply parsed as: Is the probability of no systemic-related dislocation from inaction times the welfare gains from such inaction > than the probability of systemic dislocation and the welfare loss from a systemic breakdown & associated economic dislocations. The PBoC should pay attention to western economist – particularly the politcally astute ones, for It is likely that these western economist are more attuned to the domestic creaking & groaning that might precede implosion.

  • Posted by bsetser

    Laurent — 2% nominal appreciation v. the $ doesn’t guarantee real appreciation v. the $ (it depends on inflation differentials) or a real appreciation v. the world if the dollar is sinking. it seems a bit too slow. China has kept its exchange rate from rising in line with its productivity growth for some time, so i suspect it needs a period of somewhat faster appreciation.

    A guess wrote:

    “In less academic terms, would you all be saying:
    1) in order to extend US demand for its exports, China has been buying US bonds (keeping US borrowing easy and the value of the dollar ‘high’ … or at least somewhat stable);
    2) China will continue to prop up the dollar until it can sufficiently develop local appetites for its goods (and China will eventually, if it has not already, ask the US to sing for its supper);
    3) China keeping its currency ‘tied’ to the dollar staves off speculation on China’s currency, preventing a more unruly domestic economy ( … not to mention the political power that it has accumulated)??

    1) is more or less right
    2) is more debatable. I would say that my holding down the value of the RMB (i.e. proppiing up the $) China is able to postpone taking some steps needed to develop domestic demand — so I don’t see China’s current policy as an “interim” step that China maintains until domestic demand organically develops. i think the cause and effect relationship is a bit more complex. One other note — I suspect China tumbled into its current policy when the $ tanked v. many currencies in 02-04. China didn;t plan to peg to a depreciating currency — it just happened. and then when China’s economy responded very strongly to the depreciation of the $ and RMB it became hard for China to change course.
    3) I don’t think this is accurate. China’s dollar peg invites speculation, because it seems unlikely that China will be able to maintain its dollar peg for long. Folks believe the RMB should be allowed to appreciate, so they move their funds into China. And those inflows in some ways have made China’s internal economy more not less unruly.


  • Posted by Anonymous

    Thank you very much for your thoughtful reply. If I may ask another few questions?
    re 2: I see that I attribute too much control to China. Instead they are riding a tiger and have to find a way off?
    Also re 2: it is not clear to me why it is in China’s interest to postpone domestic demand. It must involve risks and expense. As propping up the $ involves risks and expense (probably not the same ones)?
    re 3: maybe “staves off stampede”, instead of “speculation”?

  • Posted by DOR

    Anonymous, if I might jump in:

    Most observers attribute far too much power to the PRC government, and far, far too much weight to central planning.

    The “riding a tiger” analogy is correct, but blindfolded and with hands tied would be closer.

    If the typical economist is trying to steer a car down the highway by looking in the rear view mirror, then Chinese economists are looking at the mirror through a kaleidoscope.

    Or, maybe the best analogy is scalpel and sledgehammer policy tools.


  • Posted by ReformerRay

    DOR and I share a common failing. We jump in after most of the commentators have left the scene.

    So much commentary about China on this post I believe to lack sufficient appreciation of the importance of the problem of retaining control of a government in the modern era. What follows is essentially an essay on that theme.


    The communist party of China has done a tremendous job in guiding their country through the process of becoming a modern nation.

    They had the advantage of knowledge of previous history. It is to their credit that they we able to take useful lessons from history.

    1. The western world has shown that market forces and financial rewards to individuals and organizations for good work are essential to modernization.
    2. Colonialism has shown that previously developed nations are all too eager to exploit undeveloped countries.
    3. The collapse of the Soviet Union (and the failures of so many African nations) has shown that control over the use of force in a territory by a government is the first requirement for modernization.

    Years ago, The Economist, described the beginnings of industrialization in China as the marriage between entrepreneurs of Chinese descent living outside China (Taiwan, primarily) and their relatives living in China. The Taiwanese provided the machinery and know-how and the leaders of the rural communes provided a disciplined work force. Developed world moves into the undeveloped world, using resources that are possessed only by people of Chinese descent. Financial rewards went to the commune (and the Taiwanese), not the individual workers in China.

    Sounds reasonable. No disruption or threat to the chain of command in China.

    The Chinese have wisely retained control over inflows of investment into China. Access to the Chinese labor force comes at a price. No duplication of Colonialism in China.

    The willingness of the Chinese government to use force in Tianam Square was essential to the development of modern China. A government that is unwilling (or unable) to successfully crush a serious challenge to their right to rule the country, will not long rule the country. I remember being very impressed with the beginnings of the protests. As the days stretched into weeks, at became clear that the protesters wanted to destroy the current governmental leadership without having any substitute waiting in the wings. Moving from one form of government to another is not easy, as the Soviets proved. I may have been the only citizen of the U.S. who thought, at the time, that the Communist government acted correctly. They also acted wisely, in not moving until the protests had become less important to the average Chinese citizen.

    The Communist tradition, in which the current leadership was nurtured, has long ago recognized the need for pragmatism (after the disastrous great leap forward under Mao). They learned from that experience.

    I expect the leadership of China to continue to exhibit the same clear eyed focus on moving China into the first ranks of modern nations. Ideology has long ago been relegated to a back seat. Retention of power as an objective has not been discarded, and should not be discarded.

    Where China goes, how much power is delegated to voters will be decided in China by the leaders of the government, in response to developments in China. If the current Chinese leadership falters, or fails to change in response to problems of corruption and inefficiency, it will be up to the Chinese to create a viable successor. China should be granted the same freedom to develop its own form of government as the U.S. grants to itself.

    The United States should cease trying to tell China what they should do because it will be in the best interests of China. Their leadership has shown itself to be much more nimble footed than western nations. China leadership is perfectly capable of deciding what is in their own best interest. At the same time, the United States should look to its own future with the same clear-eyed selfishness as the Chinese are exhibiting. If defense of the future of the U.S. requires some degree of conflict with China, so be it.

    There should be room in the modern world for a powerful China, alongside but not instead of, a powerful Japan, Germany, United States, India and other nations.

    The United States should quickly discard any notion of being the leader of the free world. The modern U.S. has not shown itself capable of protecting its own interests, much less the interests of other nations.

  • Posted by ReforemerRay

    As for Brad’s testimony. Very impressive mastery of data and reasonable conclusions.

    I still have the feeling that Brad’s advice is somewhat conflicted, in that it is directed at the Chinese leadership but it does not look at the problem solely from the perspective of what will maintain and increase the power of both the nation and the current leadership. I assume that expansion of control over their own environment, including trade, is their objective. If I am right, rebalancing can be done by someone else. They see themselves as possessing all the trump cards. They see no difficulty, for China, in continuing along their current path. Brad’s and others discussion of potential problems they are likely to encounter seem weak to me. Whatever others do, they will find a way to take care of China.

  • Posted by Joseph Wang

    Curious thing, I read McKinnon’s editoral in the WSJ, and it made a lot more sense to me than the paper linked to this article. In the WSJ article, he says that he supports the current appreciation which he asserts just matches US and China inflation rates. What he is against is a sudden appreciation.

  • Posted by bsetser

    Right — in other words, McKinnon does not want any real appreciation in the Chinese exchange rate over time (at least relative to the us dollar), and if the dollar falls, the RMB would still depreciate on a broad-trade weighted basis.