A blog on Chinese economy & society

Currency War

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You know it’s election year when the media is full of propane gas. After New York Times’ press release yesterday arguing it’s all China’s fault, Martin Wolf at the FT is chiming in as well. He’s also attacking Germany along the way. The article is so dumb I was surprised that Yves Smith at Naked Capitalism chose to highlight it. I’m reproducing the discussion I had with her underneath.

Cindy6 says:

March 17, 2010 at 3:38 am

I can argue just as well it’s the debtor nations that want to have their cake and eat it. If they don’t want these trade deficits, tighten up. There will be no funny money to spend on imports anymore. They can also enhance their competitiveness by cutting prices, which no one on this planet or mars can do anything to stop, and boost exports tremendously. But no…that will be too painful for the civilized people. You see, only Latinos and Asians should be subjugated to stiff austerity programs administrated by the IMF.

Deflation is not really that scary if you’re a creditor (I know, I lived thru one. It’s wonderful, ur purchasing power kept increasing:) Just like inflation is much more palatable to debtor. Yes, China and Germany don’t want to foot the bill for global imbalances. But then, why should they, it’s not like the debtors are doing anything remotely helpful. At least the Greeks tried…

  • Yves Smith says:


    The creditor nations are the ones that took steps to keep their currencies cheap and preserve their surpluses. For instance, China has been running a currency peg since 1994.

    Moreover, what is true for you as an individual creditor is not true for a creditor nation. Creditor nations do much worse in deflationary periods. They have to restructure their economies fundamentally, which leads to widespread unemployment. The debtors merely default selectively and depreciate their currencies. The historical record is pretty clear on this issue.

    • Cindy6 says:

      Was the RMB/USD exchange rate considered cheap back in 1994? I don’t think so. In fact, I remember quite well China was under tremendous economic and political pressure to DEpreciate during the ‘98 crisis, as most other Asian currencies did already. Even Japan succumbed, at a great expense to its prestige within Asia. So you see, the peg has never been a tool to accumulate surplus, but a vote for stability. Besides, no one called the RMB cheap back then, why is it cheap now after after a 20% appreciation?

      Basically global imbalances need to the debtor nations to consume less and the creditors to consume more. But now, the debtors are not willing to do anything serious, so why should the creditors care? Of course, this will not end well. So it would become a game a chicken and a war of attrition.

      As for the pain suffered after the endgame, I would postulate that the creditors will last a LOT longer, since their savings will alleviate unemployment. In fact, this is the other side of Keynesian that the likes of Krugman never talk about. Fiscal stimuli should be funded by money saved up during good times. China can keep the factories humming with its reserve, for a while, and give the products to the peasants. In fact, this is the essence of last year’s rural home appliance program. There’s talk of continuing with another rural home improvement program. Given the disaster in SiChuan, I think this will be money well spent.

      Another factor you should bear in mind in your comparison w/ GD1 is that China’s urbanization rate is barely 45% now, about the level of the US in the 1910’s. Worst comes to worst, the migrant workers can just go back to their farm. Unemployment will not lead to starvation. The labor shortage we hear about this year is partly aggravated by workers don’t bother to return to the factories after the economy improves.

      Now, what could the debtors do? They can default of course. Existing debt has never been the problem. The problem lies in their fiscal deficits, that they need fresh, new money to continue their day to day existence. Even if the debtors default selectively, do you think the other investors will continue lending at these rates? And if you think losing an empire, suffering a horrendous war, and losing a reserve currency is actually doing better, then we live in alternate universe.

      The bottom line is if inflation is more preferable to deflation to the creditor nations, then we wouldn’t be having this discussion. China and Germany are only doing what’s in the best interest of their citizens. The same reason why the Fed will continue printing, to the detriment of other nations.

Yves Smith says:
March 17, 2010 at 5:57 am


First, deflation is not a healthy state of affairs. Look at Japan, look at the US late 19th century where there were farmer uprisings, the UK in the early 20s. The deflation imposed on countries at various times is considered to be the prime reason that no one now (save gold bugs) wants to go back to the gold standard. Mild inflation is considered to be the least bad of monetary growth choices, and there is a school of thought that the view that 2% was a good level might be wrong, there is now some thought that somewhat higher levels might be better. I have no idea re the optimal level of inflation, but deflation is destructive to growth.

Any currency peg (if a hard peg, which China’s was, and is still pretty hard) will lead to distortions. I say later in this thread quite explicitly that when China’s peg became too low is subject to debate (some say as early as 1999) but there is no question it was too cheap by 2002.

Re urbanization, the 45% figure you cite is based on China’s own distorted metrics. China has unusually high density thresholds for a community to be classified as “urban”. Many significant manufacturing centers are called “villages” or “towns” when no one from abroad would call them that. Houston and Brisbane would also be “towns” in the Chinese schema.

Your charge re debtor nations is off base. Unless a country goes into a trade surplus, it is impossible for it to lower its outstanding debts on an aggregate level. So China’s insistence that it keep the RMB cheap to maintain its surplus with the US means we will continue to get more into debt. If you want the US to delever, there is no way other than for the US to go into a trade surplus, or at least lower its trade deficit substantially so its GDP growth rate will exceed its rate of debt accumulation.

Cindy6 says:
March 17, 2010 at 3:50 pm

“Any currency peg will lead to distortions.” Bretton Woods led to distortions? Stable currency and prudent fiscal policy are of no use to the world?

“urbanization…figure you cite is based on China’s own distorted metrics” So the US std is the truth and only truth now? The fact that many Chinese towns had higher population density 200 years ago than Houston now should never be considered? For the record, Japan defines its urban area as population density of 4k ppl / 1sq. km. , compared to 1k in China and 386 in the US. I don’t have the corresponding figures for S. Korea & Taiwan at hand, but I bet they converge towards China rather than that of the US.

“China’s insistence that it keep the RMB cheap to maintain its surplus with the US means we will continue to get more into debt.”
Not true. The US (or France or whichever) can always increase exports and depress imports by lowering prices. Yes, this is deflation I’m arguing for. This was how Germany regained its competitiveness in the 90’s, by “internal depreciation”. And yes, it’s painful, which is why the Germans now absolutely refuse to let the debtors whine their way out of the medicine and steal their hard-earned savings.

“If you want the US to delever, there is no way other than for the US to go into a trade surplus”
Not true either. The debtors can delever by good old fashion default. What can China do to a nuclear-armed soverign nation? Not even the PIIGS are pushovers. This is unsecured credit card debts! Trade deficits self-correct. China via UST, Germany thru bank loans. All the debtors have to do is get their fiscal house in order and the threat of higher interest rate would be a hollow one. But then, this would mean Austerity. How dare those sneaky parasitic savers!

So, at the end of the day, trade war is inevitable.


Written by Cindy Luk

March 17, 2010 at 10:00 am

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