Wofgang Munchau on the Chinese Renmimbi Manipulation

If you are interested in what happens in the world, please read this article by the FT's Wolfgang Munchau.It summarises the economic logics underlying the discussions about Chinese monetary intervention. More importantly it argues for a forceful approach to Chinese monetary manipulation. I'm a big fan of his blog, and even if I don't always agree with him, he is always insightful, clear and fair. He mentions an article from VoxEU contributor and Centre for European Policy Studies' Director Daniel Gros, which very intelligently argues for the use of reciprocity in arguing for capital controls, which would be legal, apparently, against the much touted trade wars.I agree with these means, as it seems nothing better exists. However, I believe his analysis may be slightly myopic.

First of all, what would be the consequences of a renmimbi fluctuation? According to the Chinese, it would create unemployment and social chaos. According to Mr Munchau, those economic problems could be solved by inward investment and, if I understood him well, by unemployment benefits. I'm sure the Chinese officials are exaggerating in their pessimism, but isn't Mr Munchau as well in his optimism? I must agree though that the proposals for financial rather than trade punishments do make sense. However, how politically feasible are they? That brings me to my second point.

The year that these countries restrict Chinese access to their financial sector, is the year all (sovereign) bonds' interest rates will go up, and that's never popular. Here I disagree with Mr Gros argues that this should not be too painful for Europe who overall operates a balanced budget. I am surprised that a person of his caliber with the insider knowledge that he has about European policy would state things in this manner. The EU coutries might have a balanced budget, but that budget is at best a weighted mean of the 27 prevailing budgets. This is simply irrelevant, because there is no sizeable EU budget with sufficient fiscal transmissions between member states. So his argument may make a lot of sense for Japan, but until the EU comes up with a mechanism for default, which would allow Greece to restructure its debt, it still depends on Chinese money to finance itself, so this is a threat the EU cannot credibly make. Cut that recently established life-line and it all goes back to the way things were in May 2010. Moreover, Ireland, Portugal, and Spain are still knee deep into their own debt messes. To actually do this without some form of safety, would trigger a domino effect. The yields would jump up in Greece, Portugal, Spain and Ireland. This would scare the markets beyond recognition, and create a race out of the Euro the likes of which we haven't yet seen. Germany doesn't want to bail them out, nor does France really, but they wouldn't have much of a choice. They'd probably end up using the fund set up in May, but this seems all too far fetched. It's much easier to wait it out and get the Chinese to lend us money instead.

The benefit of a more expensive Renmimbi and stronger GDP will effectively only come after expensive deficits, which might cost the USA's and the EU's private sector some rather high taxes. This could worsen things here even more, and potentially limit the benefits of the policy on the whole. Plus even if their economy takes the shock well, the Chinese bureaucratic backlash against European companies might be huge. These are guys who work pretty much on a tit-for-tat mentality. In the long run, it might also not do much for the rest of the world. China might just invest domestically while continuing to export through a manipulated currency. Eventually it might create an appetite for imports in China, but wouldn't this policy just hurt us? Would it be credible? Would it really be a stick at all? If the policy is not feasible in the short run this becomes an academic discussion, not a policy one.

I say that for the time being we can afford this state of affairs. Unemployment of 10% sucks but it's not worth the trouble. It's good though to push them a bit, because if things get worse around here, we're going to need to share the pain, and then it can't be a risk. Moreover I maintain that we need to build bridges. These are serious people with legitimate concerns ( although I may personally question the legitimacy of their political system). In their position we might be inclined to have done the same. There's nothing exceptional about currency manipulation. Just look at Europe in the 1980s and early 1990s. Their problem is risk aversion, fuelled by uncertainty of their system's ability to absorb the shock of widespread unemployment and social unrest. Moreover they have probably been living with a number of bubbles. If their currency appreciates what's to stop the real estate market from crashing? And then they'll ask us to please tell them what happens to them. However what we should fear is what happens to us. China is the USA's 2nd and the EU's biggest trading partner, so we should be as affraid of total collapse in China as the Chinese themselves. So again I reiterate we need something that moves them in the right direction, slowly and consistently. And we need to engage them and open ourselves honestly to them in order to build trust so that they may be receptive to our suggestions of political reform. Finally we also have our fair share of reforms to carry out. However it is true that time is running out, and such a phenomenal bridge making political defice may very simply not exist. To Mr Munchau and Mr Gros's credit I may be asking us to build a bridge to nowhere...