Financial Times, October 7,2010
I share the growing concern about the misalignment of currencies. Brazil’s finance minister speaks of a latent currency war, and he is not far off the mark. It is in the currency markets where different economic policies and differenteconomicandpoliticalsystemsinteractandclash.
The prevailing exchange rate system is lopsided. China has essentially pegged its currency to the dollar while most other currencies fluctuatemoreorlessfreely.
China has a two-tier system in which the capital account is strictly controlled; most other currencies don’t distinguish between current and capital accounts. This makes the Chinese currency chronically undervalued and assures Chinaofapersistentlargetradesurplus.
Most importantly, this arrangement allows the Chinese government to skim off a significant slice from the value of Chinese exports without interfering with the incentives that make people work so hard and make their labor so productive. Ithasthesameeffectastaxationbutitworksmuchbetter.
This has been the secret of China’s success. It gives China the upper hand in its dealings with other countries because the government has discretion over the use of the surplus. And it protected China from the financial crisis, which shook the developed world to its core. For China the crisis was anextraneouseventthatwasexperiencedmainlyasatemporarydeclineinexports.
It is no exaggeration to say that since the financial crisis, China has beeninthedriver’s
seat. Its currency moves have had a decisive influence on exchange rates. Earlier this year when the euro got into trouble, China adopted a wait-and-see policy. Its absence as a buyer contributed to the euro’s decline. When the euro hit 120 against the dollar China stepped in to preserve the euroasaninternationalcurrency.Chinesebuyingreversedtheeuro’sdecline.