India's role in a multi-polar world - Alfred Herrhausen Gesellschaft

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Through a billion voices: India’s role in a multi-polar world
on manufacturing has led to both internal and external
imbalances. The share of residential income in GDP
declined by 18 per cent over the last 15 years; 2 that
is, improvements in ordinary people’s lives have not
caught up with the country’s phenomenal pace of
growth. Accordingly, consumption as a share of GDP
has declined by 15 per cent in the same period. 3
In expanding international trade, China has also
accumulated large current account surpluses that
have to be reinvested in developed countries,
noticeably the United States, but with low returns.
To maintain a fixed exchange rate against the dollar,
the central bank has to accumulate large amounts of
dollar reserves, which leads to constant inflationary
pressure on the economy. Most economists in China
agree that serious structural adjustments are needed
to correct these imbalances and increasing domestic
demand is at the core of this adjustment process.
It has become common place for people to blame
global imbalances on the inflexible exchange rate
regimes of some surplus countries, most particularly
China. In addition, holders of more extreme opinions
also point to China’s inflexible exchange rate regime
as the root cause of unemployment in developed
countries and the slow recovery in developing
countries. 4 But historical evidence shows that
exchange rate regimes have little to do with global
imbalances. Germany and Japan both have a floating
regime, but both countries run very large surpluses.
In particular, Japan has remained a strong exporter
despite the Plaza Accord forcing the Yen to float and
revaluate.
China’s own experience since 2005 also flies in
the face of this claim. Between 2005 and 2008, the
Renminbi appreciated by about 20%, but China’s
trade and current account surpluses both surged.
To blame the value of the Renminbi for causing
unemployment in developed countries is wrong. If
global imbalances are not related to exchange rate
regimes, employment will not pick-up even if the
Renminbi appreciates.
The claim that a weak Renminbi hurts China’s
trade competitors has some merits. But one has
to remember two things. Firstly, the Renminbi is
only pegged to the dollar and floats against other
currencies together with the dollar. If the Renminbi’s
value is artificially low today, then there are other
periods when it will be artificially high. For example,
the Renminbi was not devalued in the Asian Financial
Crisis while most Asian currencies were.
Secondly, it has to be remembered that there
are costs associated with having a fixed exchange
rate regime, which other countries may not want
to bear. For example, when liquidities are flowing
to emerging markets including China, a flexible
exchange rate regime discourages the movement
through revaluation of the home currency and avoids
asset bubbles, but a fixed exchange rate regime
cannot do this.
So when we turn to China, we have to question,
why it insists on pegging its currency to the dollar.
The cause is not mercantilism aimed at boosting
Chinese exports, as most like to believe. Experts
and government officials inside China have realised
that heavy reliance on exports is creating serious
problems for the Chinese economy. In addition,
moderate appreciation of the Renminbi will not affect
exports, as China’s experience between 2005 and
2008 has shown.
The Chinese central bank’s concern for the value
of its dollar assets is another invalidated argument.
The fixed exchange rate forces the central bank to
issue interest-bearing bonds to reduce the money
supply caused by its purchase of dollars. The net
impact of this on the central bank’s balance sheet is
thus unclear. The only explanation is political. In other
4 For the first claim, see Paul Krugman’s New York Times column, “Chinese New Year”, on January 1, 2010 at http://www.nytimes.com/2010/01/01/
opinion/01krugman.html. For the second claim, see Arvind Subramanian’s Financial Times column, “It Is the Poor Who Pay for the Weak Renminbi” on
February 4, 2010 at http://www.ft.com/cms/s/0/fc056484-10fb-11df-9a9e-00144feab49a.html.
Growing pains: global adjustment architecture | Yang Yao