7c0f440446f86f380e840d27_pa3613c.jpg Paul Lachine

Wanted: Chinese Leadership on Currencies

If China fails to live up to the responsibilities of leadership, the global currency system is liable to break down and take the world economy with it. Either way, the Chinese trade surplus is bound to shrink, but it would be much better for China if that happened as a result of rising living standards rather than global economic decline.

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.

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