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?




I think you underestimate the ability of China to manage its economy. The Chinese leadership is well educated and do have a knowledge of economics. However, with 1.3 billion people to govern, China has more than just a simple inflationary problem. Rising costs as we know, do cause more production, and that brings inflation down, as long as interest rates are not allowed to spiral out of control.

I am surprised to see that China is blaming the Fed for "Printing too much Money." But we see this charge frequently from people who should know better. The Fed does not print money, the Treasury is the only US institution that can print US money. The Fed, as you Mr. Krugmam, and others do know, allows the banks to circulate more money, by lowering the reserve requirements, or by lending money from the reserve to the banks. And that money has to be paid back. Some inflation is the result of the Treasury printing more money, and that is the theory behind the gold bugs rush to buy gold these days. But inflation as we know it, is more from a rise in interest rates. When the cost of borrowing goes up, the cost of goods and services also rise. For instance, the inflation of the Carter administration, was due to the price fixing attempt by the Nixon administration, which created shortages, and caused prices to rise, and also caused interest rates to reach historically high levels.
There was no increase in the money supply, just a shortage of cheap money.

A one time, one Renminbi tax on all citizens in China would collect, $0.16 x $1.3 billion,=$20,800,000. You must not remember when cheap Japanese products were flooding the market. and before that, it was cheap German products. No Mr. Krugman, I am not worried about China, I am worried about the new congress cutting off funds for our own development. We need to upgrade the infrastructure. We need to start building High Speed Rail, but the auto, airline and oil industries are opposed to that, and now that their Republican friends are back in power, we will not get those things. We will have to suffer another depression, while the Republicans, reward the plutocrats, and the know nothings, by stopping programs that benefit the middle class.

The Chinese are smarter than that, they are working to bring the middle class up to a standard unseen in China previously. Who do you think is buying all those cars, riding the HSR, shopping in those markets? Their economy will continue to grow at a rate that we can no longer imagine.
There are 16 or 18 million people in Shanghai alone, and 14 or 16 million more in Beijing. there are several smaller cities that have greater populations than Los Angeles or New York, which would be considered small cities in China. We know that just providing for these populations makes wealth grow.

Inflation scare is a red herring as I see it, I am worried more about our government not keeping up with the times. The Chinese are opportunists. What we do not produce for ourselves, the Chines are just waiting to produce for our consumption. If we do not fund science and DNA research, the Chinese will fund them, and sell to the world. if we do not build HSR, we will eventually pay more for travel between cities, and more of our income will be spent on commuting, than on investing in new industry.

the Chinese do have problem, the can not just allow democracy to run wild. One billion 300 million people, each going their own way, would be chaos. Just look and see how much freedom has been allowed since the Great Revolution. it is gradual, but is increasing in speed as the population becomes more economically independent.

We better learn how to work with China, or we will not keep our standard of living as we now know it.
HIGHLIGHT (what's this?)
Hong Kong
January 21st, 2011
10:13 am
To be fair and balanced, what are the (negative) consequences of letting RMB rise freely ?
Perhaps a lot fewer jobs created ?
And how is this a good thing for China, or the world ? Isn't US trying to achieve exactly what China has - higher inflation, higher employment ?
It strike me that the monetary policy in China is doing exactly the right thing - balancing between job creation and tolerable level of inflation, walking a tightrope between the two goals, and tweaking it as we go along.
HIGHLIGHT (what's this?)
Aachen, Germany
January 21st, 2011
10:16 am
China-bashing is a ridiculous hypocrisy and doesn't help.

Globalization rules were installed by the USA with the main objective to maximize the profits of international corporations. The strategy worked well, but it was short sighted.

The Chinese understood the rules of the game and saw their chance in getting the jobs. They did the sweat jobs for little money but had a long-term agenda. This strategy also worked well.

Now the US corporations have the money and the Chinese have the jobs. If we want to blame somebody we should blame our Administration and our CEOs. All we can bring forward against the Chinese is that they aren't stupid.

The logical way to escape from this self built trap is to make Chinese imports more expensive. Traditionally this is done by tariffs. But this road is blocked by the dependence of the US corporations on free trade. The alternative is to manipulate the currency exchange rate. Trying to do this, the USA are now offended that China reacts and defends its interests.

We see a classical chicken game: The USA print money to get the dollar weak and to promote inflation in China. The Chinese try to limit the impact of the dollar on their domestic economy and to get out of the dollar by investing in commodities and Euro bonds.

In any case, the jobs will not come back by China-bashing. The USA must learn to think and act long-term instead. This means to put jobs above corporate profits. But blaming the Chinese is easier than to realign a domestic policy towards the interests of the working people.
HIGHLIGHT (what's this?)
Jaipur, India
January 21st, 2011
10:17 am
The only plausible reason, why China seems obsessed with keeping its currency, renminbi, undervalued in relation to global market exchange value, is because it has hitherto helped its export driven economy to emerge as the second largest in the world, but how long could China sustain this export led economic miracle, without addressing the other fundamentals of economy, like sectoral balance in economy, domestic savings, control over inflation, narrowing of income disparities, broad-basing production, boost to domestic demand, productive employment conditions, and realistic levels of wages and prices? Though early signs of overheating of the Chinese economy, like the rising inflation, lower wages and prices, and credit crunch, are already visible, China seems to be blind to this related aspect of economic development, and unrelentingly chasing the race to emerge as the world's number one economy, without being bothered for the consequences, which might result into an economic implosion with serious threat to social and political stability of China.
HIGHLIGHT (what's this?)
Ron Teller
Taipei, Taiwan
January 21st, 2011
10:25 am
While obviously your specialty is the economic sphere, it is necessary not to forget that economic problems that may result from the artificial support of a weak Yuan will definitely bring consequent political problems. ...The one thing that the Communist Mandarins are truly afraid of. Anything that detracts from a docile population and results in social instability will result, necessarily, in very strong arm policies internally to quiet any restive social actions, whether on the internet or physically in the cities.
What happens then will be interesting, to say the least...
HIGHLIGHT (what's this?)
Paul Wallis
Sydney, Australia
January 21st, 2011
10:45 am
Prof. Krugman- You can make more sense out of this than I can:

1. The provisions of the current Five Year Plan include the imperative to develop a strong consumer economy to start to defuse the reliance on exports, as well as to create the logical second tier of the new Chinese society. Ergo, incomes must rise in real terms.

2. The Chinese will shut factories if their profit margins aren't right.

3. The US largely hit itself with the maquiladora effect over time, to cut costs in production and is now locked in to China. It's producing profits, but undermining the capital base of Main Street and "redesigning" the US economy.

Doesn't this represent a sort of cycle of mutual damage? If the yuan rises, sure, the Chinese will be able to buy more imports, but the US products would also become more expensive, wouldn't they? If the Chinese costs translate into more dollars, where does that leave the US companies?

China holds a lot of US dollars, and if they upvalue their currency, they lose instantly, like the Japanese did with the rising yen.

Some of us aren't doing too badly out of China's rise. As a matter of fact, since our Australian dollar is now roughly par with the USD, a Chinese currency rise wouldn't do us much good.

The world also doesn't need further upsets "on principle". Every time a major currency rises, it seems to create a lot of waves. The logical extensions of a real rise in the Chinese currency would include a lot of ramifications in terms of acquisitions and "creating capital" in China's rather top heavy income distribution and markets. If they've suddenly got that much more money, what can they do with it?

The US has done itself no favors in terms of its dealing with China. Wouldn't it be simpler for the US to get going with ground level economic reform and a New Economy/High Road model than try to tinker with the old Model T economics, which let's face it, are having a very close look at their expiry date?

Always enjoy reading your stuff, but this particular US policy perspective... a bit of introspection can't be that wrong, can it?
HIGHLIGHT (what's this?)
Jake Wagner
Santa Barbara, CA
January 21st, 2011
10:47 am
Krugman has been highly critical of Chinese economic policy. However, it is important to keep in mind that although China has adopted many of the ideas of free market capitalism, it is a planned economy, in accordance with the ideas behind communism, and there is no reason why central planners accepting this orientation would use the precepts of free market capitalism as a foundation for economic policy.

Implicit in macroeconomics is the notion that GDP is the quantity that governmental policy should maximize. Aggregate demand and aggregate supply and concerned with GDP and income, variables which have a built-in agenda. If central planners want to minimize unemployment, for example, rather than maximize GDP, or want to maximize a GDP that is weighted with prices NOT determined by the free market, then the planners will come to a different conclusions than economists practicing traditional economics.

It becomes even more complicated if one takes a long-term view, and considers population as one of the variables one wants to manage. Then even traditional economics would dictate that one should replace by GDP per capita. Maximizing GDP instead of GDP per capita implies a pro-natal policy. On the other hand, maximizing GDP per capita in the long run would seem to imply policies preferring smaller family size, such as China's one child policy.

Exchange rates are one of the variables that a planned economy must manage in accordance with its more complex goals, something other than GDP being maximized. It seems likely that the Chinese leaders are not convinced by arguments based solely on GDP, thus Krugman's prescriptions would fall on deaf ears. In any case, we must admit that Americans, with trained in economics or not, have little leverage in altering Chinese economic policy. Although we can ponder the consequences of their actions, we cannot expect that Chinese exchange rate policy will be based upon the same addiction to GDP that governs policy in the US.
HIGHLIGHT (what's this?)
January 21st, 2011
11:25 am


You said "Credit limits are proving hard to enforce and are being further undermined by inflows of hot money from abroad.".

Professor, thanks for mentioning the role of hot money flow with regards to dilemma that developing countries are facing. Sir, is it wrong to conclude that much of the hot money that is flowing into developing economies like India, Brazil, and China, is the same one that US Fed is donating to TBTF banks via QE2? This flow of hot money is not allowing countries to increase their interest rates for the fear that more money would flow, thus making monetary policy ineffective. Ok, for China, the option left is to let increase their currency value. In a sense, QE2 may force China to take appropriate and required corrective action of revaluing their currency, so this hot money flow can be justified as an arm-twisting tactic for a specific goal. But what about other countries like Brazil, India, etc? These countries do not manipulate their currencies, but still face the same problem of inflation and same dilemma that they can not increase interest rate as more hot money flow will make it ineffective, and for no fault of theirs. Sir, what are the options for them in presence of inflation and hot money flow?

Now, this particular role of hot money flow is why most countries and a few economists like Joseph Stiglitz and Micahel Hudson were objecting to QE2 policy. Nothing wrong with distributing money to own people to increase demand, but QE2 is definitely not doing it and handling the money to TBTF banks which they are putting in developing world. Now you expect that all other currencies will appreciate against dollar so that US gets an edge in exports. And you also admit that if China (and other countries?) do not revalue their currency, there will be collateral damage. So, how will you absolve policies like QE2 from impending doom that you are projecting?

Sir, it looks like that unless USA puts regulatory controls over money flowing out of USA, its a lose-lose proposition for everyone (including USA), irrespective of whether China revalues its currency or not.
HIGHLIGHT (what's this?)
January 21st, 2011
11:29 am
Not only medium size Chinese exporters are exerting pressure on Chinese government to keep their currency artificially low but also Big U.S. Business houses with factories in China also exerting more influence on Chinese government to continue this policy of artificially weak currency. Absence of any labor rights or labor protections, crony capitalism, artificially weak currency, lack of any environmental regulations makes China an ideal place or paradise for Big Businesses and Multinational companies whose sole motive is profit and ever larger profits.

After all who reaps the largest benefits of this artificially weak Chinese currency? It's mostly U.S. multinational companies and of course the Chinese communist party.

HIGHLIGHT (what's this?)
Toronto Canada
January 21st, 2011
11:30 am
The goof (oops I mean good) professor and the majority of the commentators are too focus on the symptoms of American economic ills instead of its root causes. Here is a simple solution. If every American wakes up each morning, go to work and try to work harder and focus on producing a better quality product or service, in stead of demanding high wages and pointing finger at foreigners. Try to consume less and save more. I am sure that the problems would be solved in a few years.
Think clearly; stop sending to power, politicians who clearly are going to work against your own interests would help too.
HIGHLIGHT (what's this?)
New Britain, Conn.
January 21st, 2011
12:17 pm
Has anyone seen the smog in China? Has anyone looked at the desires of the Chinese people. The favorite movie in China which is watched over and over by the people is "Forest Gump". There are Walmarts with huge crowds all over China, as well as McDonalds and Pizza Huts, etc. Yes! Chinese Pizza.

The biggest problem in China is not money it is the USA and our cultural reach. I have a very close chat friend in China, and I hear it all from ground level.

At Christmas there was Christmas trees decorated everywhere. The Chinese Communists are losing control, and that is Hu's biggest issue.

HIGHLIGHT (what's this?)
January 21st, 2011
12:45 pm

It has become easy to blame America's economic problems on China, and even easier to blame them on our own government but the real villian goes un criticised,,the American consumer.

No one forced you to by the cheap goods from China but you sold out your local merchant and the American manufacturing industry for cheap immitations. No small business can stand up to the cruel competition from Waltonsan. Hope you enjoy the small change you saved ...it cost you dollars in your job.

Greed will eventually out.
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George Chen
Washington D.C.
January 21st, 2011
1:21 pm
I don't think China can become a superpower by flooding the world with cheap exports, manipulating currency, accumulating vast foreign reserve and rapidly developing infrastructure hardware without software to compliment. Can you name one world famous brand name from China? Can you name one Nobel scientist of native Chinese? China still have a long way to go. For the last 20 years they are following the development model of Japan, Taiwan, Korea, etc. But these Far Eastern economies are much smaller and more developed to manage during the down turn. Once the asset bubble burst in China, it will spell disaster for the regime with strong possibil