Whatís also true, however, is that China has stumbled into a monetary muddle thatís getting worse with each passing month. Furthermore, the Chinese governmentís response to the problem ó with policy seemingly paralyzed by deference to special interests, lack of intellectual clarity and a resort to blame games ó belies any notion that Chinaís leaders can be counted on to act decisively and effectively. In fact, the Chinese come off looking like, well, us.
How bad will it get? Warnings from some analysts that China could trigger a global crisis seem overblown. But the fact that people are saying such things is an indication of how out of control the situation looks right now.
The root cause of Chinaís muddle is its weak-currency policy, which is feeding an artificially large trade surplus. As Iíve emphasized in the past, this policy hurts the rest of the world, increasing unemployment in many other countries, America included.
But a policy can be bad for us without being good for China. In fact, Chinese currency policy is a lose-lose proposition, simultaneously depressing employment here and producing an overheated, inflation-prone economy in China itself.
One way to think about whatís happening is that inflation is the marketís way of undoing currency manipulation. China has been using a weak currency to keep its wages and prices low in dollar terms; market forces have responded by pushing those wages and prices up, eroding that artificial competitive advantage. Some estimates Iíve heard suggest that at current rates of inflation, Chinese undervaluation could be gone in two or three years ó not soon enough, but sooner than many expected.
Chinaís leaders are, however, trying to prevent this outcome, not just to protect exportersí interest, but because inflation is even more unpopular in China than it is elsewhere. One big reason is that China already in effect exploits its citizens through financial repression (other kinds, too, but thatís not relevant here). Interest rates on bank deposits are limited to just 2.75 percent, which is below the official inflation rate ó and itís widely believed that Chinaís true inflation rate is substantially higher than its government admits.
Rapidly rising prices, even if matched by wage increases, will make this exploitation much worse. Itís no wonder that the Chinese public is angry about inflation, and that Chinaís leaders want to stop it.
But for whatever reason ó the power of export interests, refusal to do anything that looks like giving in to U.S. demands or sheer inability to think clearly ó theyíre not willing to deal with the root cause and let their currency rise. Instead, they are trying to control inflation by raising interest rates and restricting credit.
This is destructive from a global point of view: with much of the world economy still depressed, the last thing we need is major players pursuing tight-money policies. More to the point from Chinaís perspective, however, is that itís not working. Credit limits are proving hard to enforce and are being further undermined by inflows of hot money from abroad.
With efforts to cool the economy falling short, China has been trying to limit inflation with price controls ó a policy that rarely works. In particular, itís a policy that failed dismally the last time it was tried here, during the Nixon administration. (And, yes, this means that right now China is going to Nixon.)
So whatís left? Well, China has turned to the blame game, accusing the Federal Reserve (wrongly) of creating the problem by printing too much money. But while blaming the Fed may make Chinese leaders feel better, it wonít change U.S. monetary policy, nor will it do anything to tame Chinaís inflation monster.
Could all of this really turn into a full-fledged crisis? If I didnít know my economic history, Iíd find the idea implausible. After all, the solution to Chinaís monetary muddle is both simple and obvious: just let the currency rise, already.
But I do know my economic history, which means that I know how often governments refuse, sometimes for many years, to do the obviously right thing ó and especially when currency values are concerned. Usually they try to keep their currencies artificially strong rather than artificially weak; but it can be a big mess either way.
So our newest economic superpower may indeed be on its way to some kind of economic crisis, with collateral damage to the world as a whole. Did we need this?