China's
Threat To The Dollar Is Real
By Paul Craig Roberts
11 August, 2007
Countercurrents.org
Twenty-four hours after I reported
China’s announcement that China, not the Federal Reserve, controls
US interest rates by its decision to purchase, hold, or dump US Treasury
bonds, the news of the announcement appeared in sanitized and unthreatening
form in a few US news sources.
The Washington Post found
an economics professor at the University of Wisconsin to provide reassurances
that it was “not really a credible threat” that China would
intervene in currency or bond markets in any way that could hurt the
dollar’s value or raise US interest rates, because China would
hurt its own pocketbook by such actions.
US Treasury Secretary Henry
Paulson, just back from Beijing, where he gave China orders to raise
the value of the Chinese yuan “without delay,” dismissed
the Chinese announcement as “frankly absurd.”
Both the professor and the
Treasury Secretary are greatly mistaken.
First, understand that the
announcement was not made by a minister or vice minister of the government.
The Chinese government is inclined to have important announcements come
from research organizations that work closely with the government. This
announcement came from two such organizations. A high official of the
Development Research Center, an organization with cabinet rank, let
it be known that US financial stability was too dependent on China’s
financing of US red ink for the US to be giving China orders. An official
at the Chinese Academy of Social Sciences pointed out that the reserve
currency status of the US dollar was dependent on China’s good
will as America’s lender.
What the two officials said
is completely true. It is something that some of us have known for a
long time. What is different is that China publicly called attention
to Washington’s dependence on China’s good will. By doing
so, China signaled that it was not going to be bullied or pushed around.
The Chinese made no threats.
To the contrary, one of the officials said, “China doesn’t
want any undesirable phenomenon in the global financial order.”
The Chinese message is different. The message is that Washington does
not have hegemony over Chinese policy, and if matters go from push to
shove, Washington can expect financial turmoil.
Paulson can talk tough, but
the Treasury has no foreign currencies with which to redeem its debt.
The way the Treasury pays off the bonds that come due is by selling
new bonds, a hard sell in a falling market deserted by the largest buyer.
Paulson found solace in his
observation that the large Chinese holdings of US Treasuries comprise
only “one day’s trading volume in Treasuries.” This
is a meaningless comparison. If the supply suddenly doubled, does Paulson
think the price of Treasuries would not fall and the interest rate not
rise? If Paulson believes that US interest rates are independent of
China’s purchases and holdings of Treasuries, Bush had better
quickly find himself a new Treasury Secretary.
Now let’s examine the
University of Wisconsin economist’s opinion that China cannot
exercise its power because it would result in losses on its dollar holdings.
It is true that if China were to bring any significant percentage of
its holdings to market, or even cease to purchase new Treasury issues,
the prices of bonds would decline, and China’s remaining holdings
would be worth less. The question, however, is whether this is of any
consequence to China, and, if it is, whether this cost is greater or
lesser than avoiding the cost that Washington is seeking to impose on
China.
American economists make
a mistake in their reasoning when they assume that China needs large
reserves of foreign exchange. China does not need foreign exchange reserves
for the usual reasons of supporting its currency’s value and paying
its trade bills. China does not allow its currency to be traded in currency
markets. Indeed, there are not enough yuan available to trade. Speculators,
betting on the eventual rise of the yuan’s value, are trying to
capture future gains by trading “virtual yuan.” The other
reason is that China does not have foreign trade deficits, and does
not need reserves in other currencies with which to pay its bills. Indeed,
if China had creditors, the creditors would be pleased to be paid in
yuan as the currency is thought to be undervalued.
Despite China’s support
of the Treasury bond market, China’s large holdings of dollar-denominated
financial instruments have been depreciating for some time as the dollar
declines against other traded currencies, because people and central
banks in other countries are either reducing their dollar holdings or
ceasing to add to them. China’s dollar holdings reflect the creditor
status China acquired when US corporations offshored their production
to China. Reportedly, 70 per cent of the goods on Wal-Mart’s shelves
are made in China. China has gained technology and business knowhow
from the US firms that have moved their plants to China. China has large
coastal cities, choked with economic activity and traffic, that make
America’s large cities look like country towns. China has raised
about 300 million of its population into higher living standards, and
is now focusing on developing a massive internal market some 4 to 5
times more populous than America’s.
The notion that China cannot
exercise its power without losing its US markets is wrong. American
consumers are as dependent on imports of manufactured goods from China
as they are on imported oil. In addition, the profits of US brand name
companies are dependent on the sale to Americans of the products that
they make in China. The US cannot, in retaliation, block the import
of goods and services from China without delivering a knock-out punch
to US companies and US consumers. China has many markets and can afford
to lose the US market easier than the US can afford to lose the American
brand names on Wal-Mart’s shelves that are made in China. Indeed,
the US is even dependent on China for advanced technology products.
If truth be known, so much US production has been moved to China that
many items on which consumers depend are no longer produced in America.
Now let’s consider
the cost to China of dumping dollars or Treasuries compared to the cost
that the US is trying to impose on China. If the latter is higher than
the former, it pays China to exercise the “nuclear option”
and dump the dollar.
The US wants China to revalue
the yuan, that is, to make the dollar value of the yuan higher. Instead
of a dollar being worth 8 yuan, for example, Washington wants the dollar
to be worth only 5.5 yuan. Washington thinks that this would cause US
exports to China to increase, as they would be cheaper for the Chinese,
and for Chinese exports to the US to decline, as they would be more
expensive. This would end, Washington thinks, the large trade deficit
that the US has with China.
This way of thinking dates
from pre-offshoring days. In former times, domestic and foreign-owned
companies would compete for one another’s markets, and a country
with a lower valued currency might gain an advantage.
Today, however, about half
of the so-called US imports from China are the offshored production
of US companies for their American markets. The US companies produce
in China, not because of the exchange rate, but because labor, regulatory,
and harassment costs are so much lower in China. Moreover, many US firms
have simply moved to China, and the cost of abandoning their new Chinese
facilities and moving production back to the US would be very high.
When all these costs are
considered, it is unclear how much China would have to revalue its currency
in order to cancel its cost advantages and cause US firms to move enough
of their production back to America to close the trade gap.
To understand the shortcomings
of the statements by the Wisconsin professor and Treasury Secretary
Paulson, consider that if China were to increase the value of the yuan
by 30 percent, the value of China’s dollar holdings would decline
by 30 percent. It would have the same effect on China’s pocketbook
as dumping dollars and Treasuries in the markets.
Consider also, that as revaluation
causes the yuan to move up in relation to the dollar (the reserve currency),
it also causes the yuan to move up against every other traded currency.
Thus, the Chinese cannot revalue as Paulson has ordered without making
Chinese goods more expensive not merely to Americans but everywhere.
Compare this result with
China dumping dollars. With the yuan pegged to the dollar, China can
dump dollars without altering the exchange rate between the yuan and
the dollar. As the dollar falls, the yuan falls with it. Goods and services
produced in China do not become more expensive to Americans, and they
become cheaper elsewhere. By dumping dollars, China expands its entry
into other markets and accumulates more foreign currencies from trade
surpluses.
Now consider the non-financial
costs to China’s self-image and rising prestige of permitting
the US government to set the value of its currency. America’s
problems are of its own making, not China’s. A rising power such
as China is likely to prove a reluctant scapegoat for America’s
decades of abuse of its reserve currency status.
Economists and government
officials believe that a rise in consumer prices by 30 per cent is good
if it results from yuan revaluation, but that it would be terrible,
even beyond the pale, if the same 30 percent rise in consumer prices
resulted from a tariff put on goods made in China. The hard pressed
American consumer would be hit equally hard either way. It is paradoxical
that Washington is putting pressure on China to raise US consumer prices,
while blaming China for harming Americans. As is usually the case, the
harm we suffer is inflicted by Washington.
Paul Craig Roberts
was Assistant Secretary of the Treasury in the Reagan administration.
He was Associate Editor of the Wall Street Journal editorial page and
Contributing Editor of National Review. He is coauthor of The Tyranny
of Good Intentions. He can be reached at: [email protected]
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