Looking East to cure recession

China will be asked to import more and export less. This will spur demand and jobs in the West and economic revival.

Dr Pervez Tahir August 18, 2011

Preachers of austerity have brought growth in the United States and Europe to a grinding halt. Interest rates and inflation are extremely low. But no one — consumers, investors or governments — is spending except on the bare essentials. In the US, this spending drought is bringing the feared double-dip — recessions in quick succession — that much closer. Asia, on the other hand, has continued to enjoy high growth. Can it provide demand for more goods and services from the US and Europe to steer the world out of recession? After all, Asia’s growth depends largely on exports, which will eventually be affected by the demand constraint. In the process, can an Asian currency replace the ailing dollar?

The second and the third largest economies of the world after the United States, China and Japan, are in Asia. The Japanese economy has been shrinking after this year’s earthquake and tsunami and due to an appreciating yen. Real and substantive action is expected of from China, the leading member of the high-growth league. With ownership of $1.1 trillion in US treasury bills and total foreign exchange reserves of $3.2 trillion, she is the largest external creditor of the US and the largest foreign currency holder of the world. Her trade surplus in July alone was $32 billion. Leaving aside their traditional circumspection on economic matters, the Chinese have admonished the sole superpower on living beyond its means. They are also worried about the security of their dollar-denominated assets. US Vice-President Joe Biden is visiting China to complain, yet again, about the undervaluation of the renminbi (RMB) and a restrictive import regime. China will be asked to import more and export less. This will spur demand and jobs in the West. The proposed mechanism is to allow the Chinese exchange rate to appreciate. The IMF estimates the RMB’s undervaluation at 20 per cent. For years, China has resisted the pressure to appreciate its currency. Now this may begin to happen under the pressure of economic forces. In fact, the RMB is already beginning to appreciate. The resulting cheapening of imports will be an antidote to inflation, running at 6.5 per cent and threatening to rise. Costlier exports will yield fewer reserves, investment of which is becoming riskier and unmanageable. Exports are also beginning to be expensive as labour costs rise. Although labour costs are far lower in China than in the United States, they are rising to the extent that some Chinese manufacturers are resorting to substitute robots for labour. This will have its own implications in a country which still has a vast pool of surplus labour in rural areas. Such efforts will undermine plans to develop the domestic market. As for gains to the United States, the latest IMF estimates suggest inconsequential impact on job creation. Another study shows that more than half of a dollar spent on an import from China is attributable to the services sector in the United States. These gains could increase if the two central banks coordinate policy. The Federal Reserve’s announcement to keep nominal interest rate near zero for the next two years does provide such an opportunity. Whether China will respond in kind is another matter, especially when economists in Germany, with the third largest trade surplus in the world, are proposing a farewell to eurozone rather than bailing out weaker EU economies.

These currency battles are hastening the internationalisation of the RMB, but not its convertibility. The war to overcome the might of the dollar does not enter a decisive phase until the 2030s, when China is likely to become the largest economy of the world.

Published in The Express Tribune, August 19th, 2011.


John | 9 years ago | Reply

@Meekal Ahmed: "Stable currency" does not mean the value of it should not fluctuate. When we compare the basket of currencies as of today the $ has only lost against Yen due to appreciation of Yen rather than lost value of $, and it is terribly affecting Japan's economy.

When China convinces the energy and commodity market to take RMB in trade instead of $, then RMB will become a possible reserve currency. Will Karachi traders or Lahore farmer take RMB in exchange today or tomorrow?

US deficit is a US problem, and it is not going to affect the intrinsic trust of the $. The entire world banking and trade is denominated in $ and US federal reserve (a quasi private enterprise) and treasury (gov dept) take this responsibility very seriously, ( although not politicians, a different story) which is reflected in the investor confidence in US treasury bonds.

Deficit(Budget and trade) and reserve currency status are two separate issues altogether but people always mix these issues. In 2030 China may be a biggest economy, along with India, US, and japan but it does not mean RMB will become a reserve currency.

The day China asks the world to pay in RMB, the world will move its import to PAK, Bangladesh, India, other s. Asian countries, Africa, s. America etc. Whatever China is producing, the other part of the world is also producing now and can also produce.

Stable currency in your opinion should retain its value the same yesterday,today and tomorrow. There is no such thing for any currency including the gold.

Euro is still struggling to become a reserve currency with traders even after so many years. RMB in 2030 as a reserve currency? Will Indians and Australians accept it for the iron ore export or will OPEC accept it for oil, or will Pakistan accept it for its cotton? Will Japan, S. Korea, Taiwan, US, and Germany will accept it for its semiconductors, software, finished products, commodities etc.

Now one can understand why it is difficult for RMB to be a reserve currency.

Vinayak | 9 years ago | Reply

@Dr Pervez Tahir: Nice one.

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