Over the past several weeks, the US dollar's depreciation against the euro and yen has grabbed global attention.
a normal world, a weaker US dollar would be welcome, as it would help
the US come to grips with its unsustainable trade deficit.
because China links its yuan to the US dollar at an undervalued parity,
the US dollar's depreciation risks major global economic damage,
complicating the recovery from the worldwide recession.
realignment of the US dollar is long overdue. Its overvaluation began
with the Mexican peso crisis of 1994, and was officially enshrined by
the "strong dollar" policy adopted after the Asian financial crisis of
1997. That policy produced short-term consumption gains for America,
which explains its popularity with US politicians, but it has inflicted
major long-term damage on the US economy and contributed to the current
The overvalued dollar caused the US economy to hemorrhage
spending on imports, on jobs lost overseas and on investment to
countries with undervalued currencies. In today's era of globalisation,
marked by flexible and mobile production networks, exchange rates
affect more than exports and imports. They also affect the location of
production and investment.
China has been a major beneficiary of
America's strong-dollar policy, to which it wedded its own "weak
yuan" policy. As a result, China's trade surplus with the US rose from
$US83 billion in 2001 to $US258 billion in 2007, just before the
recession. So far this year, China's surplus has accounted for 75 per
cent of the total US non-oil-goods trade deficit. The undervalued yuan
has also made China a major recipient of foreign investment, even
leading the world in 2002 -- a staggering achievement for a developing
The scale of recent US trade deficits was always
unsustainable, and the US dollar has therefore fallen against the yen,
euro, Brazilian real, and Australian and Canadian dollars. But China
retains its undervalued exchange rate policy, so the yuan has
appreciated relatively less against the US dollar. When combined with
China's rapid growth in manufacturing capacity, this pattern promises
to create a new round of global imbalances.
creates adversarial currency competition with the rest of the world. By
maintaining an undervalued currency, China is preventing the US from
reducing its bilateral trade deficit. Furthermore, the problem is not
only America's. China's currency policy gives it a competitive
advantage relative to other countries, allowing it to displace their
exports to the US.
Worse still, other countries whose currencies
have appreciated against the yuan can expect a Chinese import invasion.
China's currency policy means that US dollar depreciation, rather than
improving America's trade balance and slowing its leakage of jobs and
investment, may inadvertently spread these problems. In effect, China
is fostering new imbalances while countries are struggling with the
demand shortfall caused by the financial crisis. The US dollar is part
of an exchange-rate Rubik's Cube. With China retaining its undervalued
currency policy, US dollar depreciation can aggravate global
Yet a mix of political factors has led to stunning refusal by policymakers to confront China.
the US side, a lingering Cold War mentality, combined with the
presumption of US economic superiority, has meant that economic issues
are still deemed subservient to geo-political concerns. All countries
have been shortsighted, imagining that silence will gain them
commercial favours from China. But that silence merely allows China to
exploit the community of nations.
The world economy has paid
dearly for this complicity and silence. It will pay still more if
policymakers remain passive about China's destructive currency policy.