* *
Dealing with the Declining Dollar
By Jeffrey E. Garten
The Jakarta Post
Monday, February 14, 2005
thejakartapost.com
fileid=20050214.F01&irec=3
The Chinese inaction on revaluation of the yuan at the conclusion of
the Group of Seven (G-7) meeting in London over last weekend was not
surprising. But it was unfortunate. True, Beijing said that it would
eventually move towards flexible exchange rates, but it has been
saying that for a long time. Without a cooperative arrangement with
China to better align the G-7 currencies in the near future, the
world economy will be at risk.
The overall global financial problem has by now been well-diagnosed.
And it has not disappeared even with the recent -- and probably
temporary -- strengthening of the greenback. Outsized US current
account deficits and the equally egregious lack of savings are
causing Uncle Sam to borrow over a billion dollars each day from
foreign creditors.
The US external debt now exceeds US$2.5 trillion, and overseas
creditors may soon demand ever-higher interest rates to keep their
money flowing into America.
Most economists prescribe a large devaluation of the dollar to
stimulate exports and restrain imports, thereby reducing the current
account deficit. The greenback has already depreciated about 15
percent against its trading partners since 2002. Some experts say it
will require another 10 to 15 percent to reduce deficits by about
half, leading to capital inflows that markets can comfortably
sustain.
A dollar devaluation of that magnitude would make the United States
economically poorer and politically weaker at a time when the need
for US leadership on the world stage -- from fighting terrorism to
championing free trade -- has never been greater. Indeed, a global
superpower with a weakening currency is an oxymoron.
How, then, should the world adjust to today's imbalances?
The dollar's descent need not be so pronounced if other countries
were to allow their currencies to move upward, and therefore, more
evenly spread the burden of adjustment. Europe is doing its part by
tolerating a super-strong euro and not intervening in markets to
hold it down. Asian governments, for the most part, are playing a
more mercantilist game by selling their currencies for dollars to
artificially suppress their exchange rates. Some governments --
Beijing being the most important -- have merely linked their
currencies to the dollar, bearing no adjustment burden at all.
If the dollar continues to sink, and if Asian currencies stay
artificially depressed, all upward pressure would shift to the euro.
China's delinking the yuan from the dollar -- the rate is now a
fixed 8.25 yuan to US$1 -- will not be the sole answer to all global
imbalances. China's exports will still be highly competitive, and it
will still need massive imports to fuel its large and rapidly
growing economy. But because of its growing regional clout, Beijing
would most likely lead the way for others in Asia to show more
currency flexibility. If China and the rest of Asia shared the
financial burden, the shift would be highly significant.
To be sure, China has some understandable arguments against
revaluation. For example, the government does not want to upset an
already fragile banking system. Further, Beijing worries that
revaluation could interfere with a growth strategy that must produce
some 25 million jobs a year to insure social stability. But there
are stronger counter-arguments.
First, China should address its domestic economic problems more
directly, by restructuring banks' balance sheets, strengthening
domestic capital markets, creating foreign-exchange hedging
instruments, improving corporate governance, and so on -- processes
which have begun, but could certainly accelerate.
Second, China has dealt with its overheated economy almost entirely
with non-market administrative dictates, such as ordering banks to
curb lending, rather than allowing market forces to influence
interest rates and currency levels. But these ad hoc measures are
unlikely to work well enough; indeed, China's goal of slowing GDP
growth has been realized only modestly thus far. A stronger yuan
could help, while also damping inflation.
Third, foreign investment is pouring into China, partly in
anticipation of upward movement of the yuan. As a result, China's
foreign-exchange reserves exceed US$600 billion, second only to
Japan. In fact, China's trade surplus has been growing, and its
reserves have increased by over 50 percent in the last year alone.
Beijing has acquired an enormous stake in the smooth expansion of
global commerce. China, and other nations aspiring to increase trade
and investment, would do better in a world where major currencies
are relatively stable against one another -- not tightly fixed, as
during the gold-standard days, but moving within predetermined
ranges. Right now the system is seriously out of kilter. The key
countries, China among them, need to devise a system where the
adjustment burdens are better shared. It is time for a formal accord
on global currencies.
The explicit goal of a new arrangement would be a one-time move to
new parities among key currencies, parities that can fluctuate
within specified ranges. China would inject some flexibility into
the yuan by, say, pegging it to a basket of currencies and allowing
a 5 percent fluctuation range. The agreement would cap the rise of
the euro, again around a range, and Japan would agree not to
artificially constrain the rise of the yen. With the burdens more
equitably distributed, the United States could avoid a huge
devaluation.
Chinese officials often think of their country as a poor developing
nation that needs a huge amount of time to integrate itself into the
global financial system. The Middle Kingdom's per-capita income may
be tiny, but by virtue of size, indigenous entrepreneurship, and
smart policymaking, the country has forced a massive change in the
global industrial structure in less than a decade.
Much more is yet to come, as China dominates global manufacturing,
moves quickly into several high-tech sectors, and sees tens of
millions of its new workers enter the global economy. The world
doesn't have the luxury of allowing a long, slow pattern of
Beijing's acceptance of more responsibility for managing the global
economy. Ultimately, neither does China.
------------
The writer is dean of the Yale School of Management in New Haven,
Connecticut. He was a managing director of The Blackstone Group and
held economic and foreign policy positions in the Nixon, Ford,
Carter, and Clinton administrations. Reprinted with permission from
YaleGlobal Online (http://yaleglobal.yale.edu). |
