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Wanted: Chinese Leadership on Currencies

WASHINGTON, DC – I share the growing concern around the world about the misalignment of currencies. Brazil’s finance minister speaks of a latent currency war, and he is not far off the mark: it is in the currency markets that different economic policies and different economic and political systems interact and clash.

The prevailing exchange-rate system is lopsided. China has essentially pegged its currency to the dollar, while most other currencies fluctuate more or less freely. China has a two-tier system in which the capital account is strictly controlled; most other currencies don’t distinguish between current and capital accounts. This makes the renminbi chronically undervalued and assures China of a persistent large trade surplus.

Most importantly, this arrangement allows the Chinese government to skim off a significant slice from the value of Chinese exports without interfering with the incentives that make people work so hard and make their labor so productive. It has the same effect as taxation, but it works much better.

This secret of China’s success gives the country the upper hand in its dealings with other countries, because the government has discretion over the use of the surplus. And it has protected China from the financial crisis, which shook the developed world to its core. For China, the crisis was an extraneous event that was experienced mainly as a temporary decline in exports.