Putting the Dollar on Steroids: Chinese Currency Intervention
Composite of Images by RightIndex from flckr CC
When China passed Japan to become the world’s second largest economy this summer,[i] the United States seemed resigned to its fate as a global also-ran. While China has only one-tenth of the U.S. GDP per capita, the U.S. unemployment rate (9.6%) hovers just below China’s GDP growth rate (10.3%), making the future of U.S. global leadership seem bleak. Not surprisingly, a plurality of U.S. respondents to a 2009 Pew Research poll named China the top economic power in the world.[ii] In reality, China’s rise is far from accomplished; the U.S. has more to gain, than fear, from a wealthy China. While Americans hold many misconceptions about Chinese policy – from debt to trade – the economic reality is more complex than it appears.
That China holds a massive amount of U.S. government debt has become a source of popular outrage for American politicians of every stripe. What is less well understood, is exactly why China keeps buying so much U.S. Debt. In fact, China must purchase U.S. Treasury bonds, even though it often takes a loss in the process. A complicated cycle has developed due to tight Chinese controls on currency outflows. Chinese exporters must convert the dollars they earn into Chinese renminbi, leaving the central government with dollars and the Chinese economy with freshly printed currency. To prevent inflation as the economy absorbs hundreds of billions of dollars worth of the new currency, the Chinese government sells domestic bonds to remove money from circulation, a process known as “sterilization”[iii]. Meanwhile, the dollars confiscated at the border are spent on the only good capable of absorbing that much money: U.S. Treasury bonds. The gap between the low rate of return on Treasury bonds, and the bond rate, in a fast growing and poor country like China often entails negative arbitrage, the difference between the rate of return on two investments, for the People’s Bank of China. To minimize their losses, China makes low rates on domestic bonds palatable by instituting price controls on necessities and banning certain types of speculative lending. This process has led China to accumulate foreign reserves amounting to almost 50% of GDP[iv] which is a staggering 4% of global GDP. This Rube Goldberg-style economic policy is not sustainable, but breaking it will involve a period of difficult transition to increased economic openness and increased Chinese domestic consumption as a component of GDP[v].
Thursday, October 28, 2010 at 3:01PM | tagged China, Rube Goldberg Machines, U.S. Dollar, economics, trade policy in Specific Facts | Post a Comment | Share Article 
