Currency War - The New Legalist

(Mr. Ben Mah, author of America and China, America and the World, America in the Age of Neoliberalism, Financial Tsunami and Economic Crisis – The End of American Hegemony, and the forthcoming China in the Global Crisis of Capitalism, is a frequent contributor to this website.)

On the eve of the U.S.-China Summit in Washington in January 2011, Senate Democrats led by Senator Charles Schumer introduced a bill to punish China for currency manipulation. Their accusation is that China’s trade and currency policies have cost America jobs as they contend the Yuan is still undervalued by as much as 40%. The provisions of Schumer’s bill include imposing duties on Chinese goods and a Federal Reserve intervention in the currency markets. “China’s currency is like a boot on the throat of America’s economic recovery,” Schumer said.^1.

Indeed, China has been an easy scapegoat for America’s economic malaise in recent years, as key economic policymakers in Washington such as Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke have reiterated on more than one occasion that China is the culprit responsible for the U.S. financial crisis. As a matter of fact, just months prior to Senator Schumer’s anti-China outburst, the Western media embarked on a campaign calling for a trade and currency war against China. Robert Samuelson, the economic commentator for the Washington Post, declared that the U.S. should invoke the Smoot-Hawley Act to impose tariffs against Chinese goods. The Smoot-Hawley Act, a U.S. law passed during the Great Depression, “was regarded as one of the principal causes of the downward spiral in world trade from 1929 to 1932 and the division of the world into antagonistic trading blocks, leading eventually to world war.”^2.

Similarly, Martin Wolf, chief economic commentator at the Financial Times, declared that “The politics and economics of an assault on Chinese exchange rate policy are increasingly convincing. The idea is, of course, deeply disturbing. But I no longer believe there is an alternative.”^3. In his column, Mr. Wolf categorically declared China is guilty of manipulating its currency by answering his own rhetorical question: “If a decision to invest half a country’s gross domestic product in currency reserves is not exchange rate manipulation, what is?”^3.

Indeed, as a result of becoming the factory of the world and welcoming foreign direct investment with open arms, China’s central bank has accumulated an enormous amount foreign currency reserves in recent years. As a matter of a fact, China’s foreign currency reserves have increased from $400 billion in 2003 to around $3 trillion in 2010, more than a seven-fold increase in seven years. Unfortunately, an increase of such magnitude has presented a huge problem for the Chinese economy. Financially, money supply and credit creation are wreaking havoc in China, diluting the value of the Renminbi, increasing inflation; and creating an asset-price bubble and bad loans in the Chinese banking system.

Moreover, as a result of mounting U.S. budget and trade deficits, the value of China’s dollar foreign currency has declined. In fact, the dollar has lost more than 80 percent of its value since President Nixon abandoned the gold standard in 1971. It is obvious that China is not only losing heavily from dollar devaluation, but is subsidizing America with cheap consumer goods to the tune of hundreds of billions of dollars a year. The reason why China has accumulated so much in foreign currency reserves is due to dollar hegemony, under which China’s export earnings cannot be used domestically. More alarmingly, as a result of constant American pressure on China for financial liberalization that allows capital to flow into China, China is accumulating ever more dollar reserves. By pegging their currency, the Yuan, to the dollar, the Chinese “have already lost a substantial portion of their dollar stake, by far the world’s largest.”^4. In fact, the U.S. has already defaulted on more than 20 percent of China’s dollar holdings to the tune of hundreds of billions of dollars over the past few years. “And they, like all others, will also lose the rest. For Uncle Sam’s debt to the rest of the world already amounts to more than a third of his annual domestic production and is still growing. That alone already makes his debt economically and politically never repayable, even if he wanted to, which he does not.”^4.

Ironically, China, being the biggest victim of the U.S. orchestrated Ponzi scheme, is portrayed by American politicians such as Charles Schumer, U.S. economic policymakers Ben Bernanke, Timothy Geithner and financial commentators Robert Samuelson and Martin Wolf as an international pariah, a scandalous currency manipulator and a great violator of global trade.

Wolf, like many American politicians, has also accused China of subsidizing her exports, claiming that China’s policy is “a significant distortion of world trade.”^3. To be sure, with the implementation of a neoliberal cheap labor policy by the U.S. multinationals, hundreds of millions of hard-working Chinese are working in the most miserable conditions, receiving meager wages and producing hundreds of billions worth of consumer goods in sweatshop factories. Those consumer goods are exported to the United States at rock bottom prices. China gets a small percentage of the profit. For example, a sweater produced by a Chinese factory at a cost of $4.00 can be sold at Wal-Mart for as much as $40.00, thereby contributing $36 to the U.S. GDP. In fact, since Opening Up, China has rescued the Western -- particularly the U.S. -- capitalist economy from stagflation. Nonetheless, China still suffers through a great deal of criticism for destroying jobs in America and subsidizing exports.

While admitting that China is not entirely responsible for the U.S. current account deficit, Wolf warns that unless the U.S. and other industrial countries move into sizeable current account surplus, there will be another round of financial crisis. To prevent the next financial crisis, Wolf declared: “China could move today’s current account surplus towards deficit, by $300 bn a year, at negligible risk.”^3.

Unfortunately, Mr. Wolf woefully ignores the fact that U.S. current account deficit is structural, and will not respond to a change in the value of the Chinese currency relative to the dollar. Actually, the American current account deficit is due to U.S. overseas military spending, speculative capital flowing into China, the U.S. multinationals increasing their investment in China, and the U.S. hedge funds buying up Chinese domestic industries at fire-sale prices and, above all, the conspicuous over-consumption encouraged by U.S. domestic policy, as “the U.S. consumption increased from about 67 percent of GDP in the late 1990s to about 70 percent in 2007, financed largely with debt.”^4. Just as Prof. Rajan Raghuram of University of Chicago aptly points out: “Unless the domestic policy strategies change dramatically, these imbalances will likely persist. Global economic stability, therefore, is not dependent on some grand agreement among countries — if you allow your currency to appreciate, I will rein in my fiscal deficit —which unfortunately seems to be the focus of recent economic summits.”^4.

According to Wolf, another option for the Chinese government is “cap ... intervention, an end to sterilization of the monetary consequences and targets for real domestic demand, household consumption and the current account.”^3. In other words, the Chinese government should cease control of her monetary policy and adopt the U.S. policy of encouraging consumption.

To allay China’s concern that a sizeable increase in exchange rate “would not only damage export industry, but risk a ‘lost decade’ similar to that of Japan in the 1990s,”^3. Wolf assures us that China today is totally different from Japan of 1985, as China’s GDP per capita is less than a fifth of the United States and therefore “has huge potential for higher consumption rates.”^3. However, one should point out that as a result of the Plaza Accord, the Japanese Yen was revalued more than four fold, from 360 Yen to the dollar to as high as 80, but this did not have any noticeable effect on the U.S. trade deficit with Japan. On the contrary, Japan simply accumulated more U.S. dollars and American consumers paid more for their imports. Japan experienced a “lost decade” in the aftermath of its own asset bubble. In view of past experiences, one wonders why U.S. policymakers and the Western media still pressure for a massive currency appreciation. What is the hidden agenda behind this currency war?

While pretending all this is for the benefit of the Chinese people, Wolf and the Washington elite do not hesitate to threaten imposing tariffs, just as the Senate Democrats did. Mr. Wolf states: “But if negotiation continues to fail, alternative must be considered. Import surcharges are one possibility.”^3. Other options include countervailing currency intervention as advocated by Fred Bergsten of Washington’s Peterson Institute. Countervailing currency intervention is used when country such as China buy dollars to prevent the appreciation of her currency; the U.S. will sell an equivalent amount of dollars to neutralize the purchase. Bergsten calls this a “fight fire with fire on the Renminbi.” Another option that may be used against China is capital account reciprocity, in which China would be denied the opportunity of purchasing U.S. Treasury bonds, thereby forcing the upward valuation of the Chinese currency. Given that the dollar is the world reserve currency and that there is plenty of liquidity in the private sector, Wolf is not worried that such a move would lead to the dollar’s collapse.^3.

In this regard, we beg to differ with Mr. Wolf, as the last option will definitely bring about a financial showdown between the U.S. and China. This would force China to abandon her current policy of relying upon trade as a driver for China’s national development. It would result in a drastic fall in the value of the dollar, as the international financial market would then lose confidence in the dollar as world reserve currency, and foreigners will lose confidence in America as the place for investment or regard America as a credit risk nation. Interest rates will dramatically skyrocket, the stock market will crash, consumer spending decline and another recession or depression will be on the horizon.

This would be a blessing in disguise for China. China is currently in a very disadvantageous economic relationship with the United States; selling her real wealth —the natural resources of China — in exchange for a piece of paper called a U.S. Treasury bond, which will never be repaid and which, in the end, will be worthless.

Abandoning her current reliance on foreign trade and, more specifically, the American market for China’s development would provide China with a golden opportunity to return to the correct path, the path of independent development, of self-reliance, of emphasis on research and development. It would also provide China with the rationale for the use of the excess foreign currency reserves to buy out American and multinationals’ subsidiaries in China.

It is obvious that Washington will not be so foolish as to destroy the U.S. dominated trade system under which American multinational firms are reaping enormous profits on the backs of Chinese workers. Nonetheless, Washington “has mounted a concerted international media campaign, mobilizing the IMF and EU to weaken China’s industrial model, blaming the rising power for its decline.”^6. From the leading columnists such as Samuelson and Wolf to the political elites such as Schumer, a campaign “is orchestrated to ‘confront’ China over a host of crimes and sins, ranging from unfair competition, low wages, state subsidies, to shoddy quality and unsafe products.”^6. China, they have said, is in crisis, there is the real estate bubble, and the Chinese banks are loaded with bad debt and are on the verge of collapse. China’s “overseas investments are following colonial patterns; the economy is unbalanced, too dependent on exports rather than domestic consumption.”^6. The U.S. and British elites have encouraged their Chinese counterparts to “influence and pressure ‘malleable’ or ‘accommodating’ neoliberal Chinese officials to change policies.” “The goal is to facilitate greater U.S. penetration and to limit China’s dynamic overseas expansion.”^6.

Additionally, Washington “also attempts to induce China’s cooperation in slowing down its decline. U.S. diplomats frame this approach by emphasizing ‘treating China as an equal’, recognizing it as a ‘world power’ which has to ‘share responsibilities’.”^6. It is a strategic move to induce China’s cooperation with the U.S. over its relations with Iran and North Korea. In fact, Washington is asking Beijing to sacrifice its strategic interests in North Korea and its commercial relations with Iran to further America’s own ends.