The Good News From Beijing

The Great Chinese Currency Manipulation Debate ended this week, with more of a whimper than a bang. China’s central bank announced that it would allow its currency, the renminbi, to trade up or down according to market demand for Chinese money -- just in time for Rolling Stone's blockbuster article on Gen. Stanley McChrystal to obliterate all other issues from the news cycle. It's worth recalling, however, what a big deal this was just a few weeks ago when Paul Krugman called on the Obama administration to "get tough" with China over trade. In March, Krugman had deplored the U.S. failure to threaten tariffs as a leading reason to despair over our economic prospects. Meanwhile, on June 13, China's state-controlled press slammed members of Congress who wanted China to let its currency trade as a "bunch of baby-kissing politicians" who didn’t know what they were talking about. But now the storm has passed, we're all friends again, and the problems are solved, right?

Well, no.

Let's start with the good news, however. For one thing, a return to amicable relations between the world's two most important economies is a good thing on its own terms. In addition, this move should be good for China. Chinese people, as I witnessed on a trip to their country a few weeks ago, are still extremely poor despite recent economic progress. Appreciation of China's currency -- making a given unit of Chinese money worth more in dollars -- is essentially a pay raise for every single Chinese worker. What's more, the increase in real wages obtained through currency appreciation may help head off the current round of labor unrest in China, because, in effect, everyone is now getting a raise. What's more, China's habit of pegging its currency to the value of the dollar meant that China was essentially importing American monetary policy, which was leading to price inflation. A floating currency should curb this problem.

Last, and in some ways least, the move should help the jobs picture in the United States. Newly wealthier Chinese people should, in theory, buy more stuff, and some of that stuff will be made by Americans. Hence jobs. To a much lesser extent, a more expensive yuan may directly boost some American industries. U.S. politicians who've been calling for this measure seem to be anticipating a large effect here, but they're probably wrong. China and the United States are very different countries. We do have at least one factory making ironing boards that competes with a Chinese firm. But by and large Chinese manufacturers compete with manufacturers in places like Vietnam, whereas U.S.-based ones compete with firms based in places like Canada, Japan, and Denmark.

The bad news is that this spells an end to China’s very loose, growth-oriented monetary policy. Letting the exchange rate float is a form of monetary tightening. That's the best choice for China, which was facing inflation, which is why it's doing it. India and Brazil, the next two large developing economies, similarly managed to avoid slipping into recession by adopting loose monetary policy and are now tightening in the face of inflation. This is the correct policy for all three countries, but it's a problem for the world -- it means the three biggest sources of economic growth in recent years are putting on the brakes.

The upshot for the rest of the world could be ugly. And the correct response should be obvious. Large economies such as the United States and the European Union, which have slow growth paired with low and falling inflation, need to do more to grow demand.

Unfortunately, things seem to be moving in the opposite direction. The European Central Bank has made it clear that it is willing to buy up government bonds to avoid a total meltdown, but no more. Our Federal Reserve Bank acted more aggressively than the ECB in the early phases of the crisis but is unwilling to go any further, even though its own research indicates more should be done. In terms of stimulus spending, the Germans are the key players in Europe, and they're cutting the deficit and urging the United States to do the same, even though were we to do so, it would likely devastate the German economy. The new coalition government in the United Kingdom is pushing a draconian austerity package that it concedes will reduce economic growth.

The good news is that the White House hasn't caught the madness. Timothy Geithner and Lawrence Summers are urging the world to do more stimulus, and they're right. But they can't get the Senate to listen, much less the Germans. An already preposterously weak jobs bill has been whittled down over and over again this week in an effort to get to 60 votes, all so far to no avail. It's a frustrating, depressing situation and threatens to undo the good news from Beijing.

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