By Kenneth Rogoff
CAMBRIDGE – Will a possibly imminent US-China trade agreement exacerbate global business cycles or even plant the seeds of the next Asian financial crisis? If the eventual agreement – assuming there is one – forces China to hew indefinitely to its outmoded, overly rigid exchange-rate regime, then the answer may be yes.
Keeping the renminbi’s exchange rate stable against the US dollar would require the Chinese authorities either to match changes in US interest rates, or go through capital-control contortions to try to offset exchange-rate pressures in other ways. But China is simply too big and too global to adhere to an exchange-rate policy that is better suited to a small, open economy.
Moreover, neither approach to keeping the renminbi stable – maintaining interest-rate parity or applying capital controls – makes sense for an economy with business cycles that seldom coincide precisely with those of the United States. With its declining trend economic performance, overbuilt housing sector, and overleveraged regional governments, China will inevitably confront politically sensitive growth problems. When it does, the People’s Bank of China will need to be able to loosen monetary conditions without having to worry about supporting the exchange rate.
When a country comes under serious financial and macroeconomic pressures, maintaining an inflexible exchange rate is a well-known recipe for disaster. The International Monetary Fund, along with most academic economists, has been making this point for a very long time.
Such an exchange-rate deal between America and China would be out of tune with other elements of a potential bilateral trade agreement, many of which are “win-win.” For example, China has pledged to enforce intellectual-property rights much more vigorously, although just how strongly remains to be seen. Greater Chinese rigor in this area may benefit American and European firms in the near term, but over the long run it will help to fuel competition and innovation in China’s own manufacturing and tech sectors.
After all, back in the 1800s, the US, like China today, had little interest in protecting the intellectual-property rights of foreign (then mostly British) firms, and Americans widely copied their ideas and blueprints. However, as American innovators became more successful, they, too, needed their rights protected, and in due course the US brought its patent and intellectual-property laws up to world-leading standards.
Another win-win could result from America’s insistence that the Chinese government refrain from lavishing subsidies on exporters. Most of these subsidies go to China’s inefficient state-owned firms, sucking credit and other resources away from the more dynamic private sector.
More generally, a trade deal may well give fresh impetus to economic reforms in China, which seem to have stalled or gone into reverse in the past few years. On a recent trip to Beijing to attend the China Development Forum, I asked a very senior Chinese official about this slowdown. I had expected him to reel off a long list of inconsequential reforms, in keeping with the usual line that China is doing things very gradually all the time. So I was surprised when he candidly admitted that “we only do major economic reforms when there is a crisis, and there has not been a big enough crisis of late.”
In this sense, US President Donald Trump seems to be just what the doctor ordered, because he has forced the Chinese authorities to recognize that they can no longer rely on American consumer demand to keep China’s growth locomotive moving. Indeed, some observers joke that Trump is the savior of the Chinese economy, because panic at a possible trade war is helping to catalyze long-stalled structural reforms.
But American pressure on China to commit to a more stable renminbi-dollar exchange rate, and avoid competitively devaluing its currency, could undermine further economic reform. In particular, such a regime would prevent China from gradually adopting the greater exchange-rate flexibility required for a more independent monetary policy.
Trump’s team seems to be under the misguided impression that China has been intervening to keep its currency weak, in order to promote exports. The view that China manipulates its currency, long overblown by some commentators, downplays the fact that the root of China’s hyper-competitiveness has long been its relatively low wages.
More fundamentally, the accusation that China is manipulating the exchange rate is completely out of touch with recent history. In recent years, the pressures on the renminbi have been largely downward, and the government has responded with much tighter restrictions on capital outflows that go both over and under the table. Far from putting a ceiling on the renminbi’s exchange rate, the Chinese authorities have been putting a floor beneath it, partly out of fear that overly rapid depreciation would lead to a massive exodus of capital.
An inflexible exchange rate might not be the only potential weakness in an eventual US-China trade deal. American negotiators also have not seemed to appreciate the accounting rule that a country’s current account (a broad measure of its trade balance) is always equal to national savings minus national investment. If American consumption growth is strong and the US government runs a massive fiscal deficit, the country has to borrow from somewhere. And if China is forced to reduce its bilateral trade surplus with America, it will simply offshore the final stages of goods production, so that US imports will be recorded as coming from another Asian country, such as Vietnam.
True, pushing China to conform to conventional global trade practices is important for the entire world. Recent speeches by Chinese President Xi Jinping are encouraging in this regard (though one wishes that the trade talks would address environmental protection). But if a final deal prevents China from gaining greater monetary-policy autonomy, it could create major problems when the next big Asian recession hits. In that case, American negotiators will have demonstrated their bargaining power, but not their wisdom.
Rogoff, a former chief economist of the IMF, is Professor of Economics and Public Policy at Harvard University.