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Wednesday, December 17, 2003

Econ 101 on China

Obviously the 'great China economy debate' is simply set to run and run: it won't be over till it's over as they say. But one thing thing is curious, the line up that it creates. These days I seem to find myself more and more with Greenspan. First the deflation danger in the US, and now China. Greenspan, speaking of all places in Texas, last week appeared to soundly reject the argument that an undervalued yuan poses a problem for the U.S. economy. According to Greenspan "a rise in the value of the (yuan) would be unlikely to have much, if any, effect on aggregate employment'' in the U.S.

On Greenspan's view a yuan revaluation, would simply transfer production to other low-wage countries. Of course I agree. On the margin this would only cause China to outsource downwards. As Bloomberg's William Pesek says: "It's not China's fault the U.S. isn't creating millions of jobs. The blame goes to a rich economy that's becoming less competitive in an age of globalization".

Greenspan's view: A yuan revaluation, as the White House has demanded, would simply transfer production to other low-wage countries. And he's right. It's not China's fault the U.S. isn't creating millions of jobs. The blame goes to a rich economy that's becoming less competitive in an age of globalization.

No doubt the White House would love to pin its job- challenged recovery on communists in China. But it's been hard to keep a straight face as executives and politicians in the U.S. increasingly scapegoat China the way they did Japan a dozen years ago.

Forgotten is that this year's 20 percent rally in the Dow Jones Industrial Average is partly a byproduct of China's rise. Companies have rushed to China because of its cheap labor and land costs. The shift resulted in a ``giant sucking sound'' not unlike the one H. Ross Perot feared from Mexico during the 1992 U.S. presidential election.

Yuan's Value

U.S. companies have pumped up profits by firing workers and moving jobs to China. The cheaper yuan allows them to set up plants, buy machines, hire staff cheaply -- and make more money. And now, the U.S. is upset that, well, China is stealing its jobs. Such hypocrisy explains why Beijing is unmoved by Washington's claims that its rich economy is being victimized by poor China.

Rickety institutions, a troubled banking system and poverty continue to plague China. Eight percent growth aside, it also faces history's greatest development challenge: introducing 1.3 billion people into the global economy. China just isn't ready to let traders decide the value of the yuan. Because of its shaky financial system, the yuan could just as easily fall as rise.

Thankfully, Greenspan exposed the disingenuousness of the China debate. Often seen as a close ally of the Bush team, he may be anything but on this issue. The Fed chairman is looking at it in purely economic terms, not political ones, like the White House.

That doesn't mean this issue is going away. Last Friday, U.S. Treasury Secretary John Snow said: ``It's awfully important the Chinese respond in coming months. They have committed to a float and that's positive.''

Keeping the Peg

Here, let's hope Greenspan's Economics 101 lesson on China gets its due of attention. Yes, Greenspan said Beijing may need to end its 8.277 peg to the U.S. dollar, but not because such a shift would lead to more U.S. jobs and exports. Rather, the step might keep its economy from overheating.

China's money supply has grown at an annual rate of over 20 percent this year because currency and bank reserves have increased. Realizing that pace may be unsustainable in the long run, its central bank has countered much of its dollar buying by reducing loans to commercial banks, selling bonds, and boosting reserve requirements.

Continued buying of dollars to maintain the peg, ``unless offset, threatens an excess of so-called high-powered money expansion and consequent overheating of the Chinese economy,'' Greenspan said. Thus, it's ``important to all of us that they succeed in navigating through their current economic and financial imbalances.'' A more flexible currency regime might do the trick.

Yet Greenspan admits that even this part of the China-should- let-the-yuan-rise argument is debatable. That's a far more useful angle from which to come at the issue, and one to which Beijing will be more receptive. China fancies itself a rising power and isn't about to let the Bush administration rush it into a major economic policy shift.

Election Year

It's no use telling that to the Bush team or U.S. senators working to impose tariffs on Chinese imports unless Beijing floats its currency. It's also no use telling them that China is buying an increasing amount of the world's exports. This campaign can be explained with two words: election year.

In 2004, many elected officials -- including President George W. Bush -- will need to explain why the U.S. isn't creating jobs. The last thing politicians want to admit is that their efforts aren't boosting U.S. living standards. They're also loath to remove U.S. farm subsidies. China makes a convenient scapegoat.

Corporate America used to blame the Japanese for its deficiencies. The Chinese are now playing that role. And U.S. politicians know it could be a winning strategy at the polls. Chances are, more than a few voters from Los Angeles to Miami will buy the idea that communists in Beijing are stealing their livelihoods.

So far those blaming China for U.S. woes haven't listened to reason. Perhaps they'll listen to Greenspan.
Source: William Pesek Jr, Bloomberg

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